The Donchian Channel or Price Channel is a trend indicator developed by Richard Donchian who is widely known to be considered a further trend. Like bands and other channels, such as Bollinger Bands and Keltner Channels, the Donchian Channel is a stretch of price depicted on a price chart where the plot is at the highest level of the high and the lowest level of the low level in a given number of periods. The Donchian canal can also be used to observe market volatility as it moves wide and narrows as price volatility increases and decreases. This indicator forms the basis of the breakout system commonly used by Turtle Trader.
The Donchian or Price Channel channel basically performs two calculations: This indicator calculates the highest level of the high level during a given back period and the lowest level of the low level in the same back period.
Some charting platforms also plot the centerline on the Channel, which is only the highest average high and lowest lows during the specified back period. The default view for the Donchian Channel period is 20.
The formula with default values is:
Upper Channel Channel = 20-period high level
Bottom Canal Channel = 20-period low-level
Middle Channel Path = (Upper Channel line + Bottom Canal line) / 2
The Donchian Channel Method identifies when the price broke high or low in the specified back period. When the price breaks through the upper Channel line, this indicates a potential upside trend and signals buy (long) and closes the open (sell) position (short). When the price broke the lower Channel line, this indicates a potential downside trend and signals sell (short) and closes the open long (buy) position.
Some traders use signals from the Donchian Channel as a stop-and-reverse, always-in-the-market system, switching from buy to sell as the price breaks through the bottom Channel line, and switches from sell to buy when the price breaks through the upper Channel line. However this is not highly recommended as it does not allow proper money management.