The Donchian Bands (or Channel), named after Richard Donchian, are bands of High and Low of price. They are very useful for projecting support and resistance levels of price and define boundaries for price action.
The Donchian Bands are calculated in a simple formulas:
Upper Band = Highest High of X periods
Lower Band = Lowest Low of X periods
X is the calculation period of the Donchian Bands.
How It Is Used
The Donchian Bands are mainly used as a breakout indicator - they define support and resistance and generate entries as price breaks these levels. Because Lows and Highs usually correlate with Support and Resistance level, this indicator is useful in objectively defining Support and Resistance levels.
However, it can also be used as a reversal signal - entering when price touches a band and reverses its direction. Before using the indicator in this fashion, confirm the validity of the psychological level by demanding at least 2 touches at the level. This ensures that the signal is strong and enhances its reliability.
Another way of trading the Donchian Band is using its Middle Band. The middle band is the average of Upper and Lower band, and can also be used to gauge trend. Entry signals are generated in the following way: When price crosses the middle band from below - buy, and when price crosses from above - sell. It can be a powerful signal when trend strength is confirmed (with Support and Resistance or indicators).
Trading with Donchian Bands
As described, there are several ways of interpreting and trading the Donchian Bands. The most commonly used is the breakout:
Long Trades - Long trades are entered when price breaks above the 20-period Upper Donchian Band. Conservative traders wait for price to close above the Donchian Upper Band to enter.
Short Trades - Short trades are entered when price breaks below the 20-period Lower Donchian Band. Conservative traders wait for price to close below the Donchian Lower Band to enter.
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