The Donchian indicator trick for easy profits
Richard Donchian was a futures trader, who is credited with creating the popular Donchian channel indicator. Richard Donchian is known as the grandfather of trend following.
The Donchian Channel is formed by using the highest high of x number of days and the lowest low of the same x time period, and then plotting the point between those values on your chart.
The Donchian channel is a handy indicator to watch the volatility of a stock. When a price is stable, the Donchian channel will be reasonably narrow. When the price fluctuates considerably, the Donchian channel will be much wider. Its main use, however, is to give signals for long and short positions. If a security trades above its n-day high, then a long trade is taken. When it trades below its x-day low, a short position is established. They are invaluable in predicting support and resistance price levels from an objective standpoint.
How to use
Donchian bands are typically used as a breakout indicator, it defines support and resistance levels and generates entries as price breaks through these levels. Since lows and highs generally correlate with support and resistance levels, this indicator is useful for objectively defining these areas.
Having said that, it is also used as a reversal signal: you enter when the price touches a band and reverses its direction. Before using the indicator in this way, confirm the validity of the psychological level by requiring a minimum of 2 taps on the level. This ensures that the signal is strong and increases its reliability.
Another way to trade with the Donchian Band is to use your middle band. The middle band is the average of the upper and lower band and can also be used to quantify the trend. Entry signals are generated as follows: when the price crosses the middle band from below, you buy, and when the price crosses from above, you sell. It is really a powerful signal when you check the strength of the trend with other indicators like MACD and Stochastic.
Invest using Donchian bands
There are numerous methods to decipher and trade the Donchian Bands. Probably the most used is definitely the breakdown:
1. Long Trades – Long trades are entered when the price breaks above the 20-period upper Donchian band. Conservative traders wait for the price to close above the upper Donchian band to enter the trade.
2. Short Trades – Short trades are entered when the price falls below the 20-period Lower Donchian Band. Risk-averse traders wait for the price to close below the lower Donchian band to enter the position.
Another approach to using Donchian bands is to use the middle band as a buy or sell signal line. Entry signals occur as follows: when the price crosses the middle band from below, you buy, and when the price crosses from above, you sell.
The 20 Donchian Stock Trading Tutorials
Richard Donchian began his livelihood on Wall Street in 1930. Donchian began writing a technical market letter in 1933 and continued for years. In 1934, Donchian created the following 20 trading guidelines that are based on human psychology. Human psychology never changes, so these rules continue to be appropriate today.
1. Beware of acting immediately on popular public opinion. Even if it is correct, it will usually delay the movement.
2. From a duration of boredom and inactivity, watch and be ready to follow a move in the direction of increasing volume.
3. Limit losses and increase profits, regardless of all other rules.
4. Light commitments are recommended when the market position is not secure. Clearly defined moves are signaled often enough and the focus on these moves minimizes unprofitable saw hits.
5. You rarely take a position in the direction of an immediately preceding three-day move. Expect a one day reversal.
6. Judicious use of stop orders is a valuable aid to profitable trading. Stops are useful to protect profits, to limit losses and from certain formations like the triangle approach to taking positions. Stop orders tend to be more valuable and less treacherous if used in the proper relationship to the chart formation.
7. In a market where the highs are likely to equal or exceed the lows, a stronger position should be taken for the highs for percentage reasons: a fall from 50 to 25 will generate only a 50% profit, while a advance from 25 to 50 will be compensated 100%
8. When choosing a position, price orders are allowed. When closing a position, use market orders.
9. Buy strong-bottom, strong-action products and sell weak ones, subject to all other rules.
10. Moves where the rails lead or are heavily involved are often more worth following than moves where the rails lag.
11. An analysis of a company’s capitalization, the degree of activity of a problem, and whether a problem is a slow racehorse or an energetic racehorse is as critical as a study of statistical reports.
12. A move followed by a sideways range often precedes another move of nearly the same extent in the same direction as the original move. Usually, when the second move from the sideways range has run its course, a counter move that approaches the sideways range can be expected.
13. Reversal or resistance to a move will likely be encountered:
A. By reaching levels where before now, the commodity has fluctuated for a considerable period of time within a narrow range
B. Approaching highs or lows
14. Be on the lookout for big buying or selling opportunities as they approach trend lines, especially on medium to low volume. Make sure that said line has not been hugged or bumped too much.
15. Watch out for repeated crawls or hits of major or minor trend lines and be prepared to see trend lines broken.
16. Breaking of minor trend lines against the major trend gives critical signals to take positions. Positions can be taken or invested in such places.
17. Aether slope triangles can mean accumulation or distribution depending on other factors, although the triangles frequently break on the flat side.
18. Be careful with volume climax, particularly after a long move.
19. Don’t rely on spaces to close unless you can distinguish between break spaces, normal spaces, and exhaust spaces.
20. During a move, take or add to positions in the direction of the market move the morning after any one-day reversal, no matter how slight the reversal, particularly if volume declines on the reversal.