Richard Donchian is referred to as the grandfather of trend trading. His initial trend following concepts make up the base for all trend following achievement which has followed. The original Donchian strategy included the application of a moving average for the entry and exit indicator part of his program.
Richard Donchian made use of the 4 week principle. Donchian's system was to buy every time a stock hit a 4 week brand new high and his awesome exit law was sell when it forms a two week low.
The Donchian channel is an indicator found in market trading made by Richard Donchian. It is created by using the highest high of the daily maxima and the lowest low of the daily minima from the last n days, then paying attention to the area between these values on the chart.
The Donchian channel is a valuable indicator for finding the volatility of a market price. Any time a price is stable the Donchian channel shall be relatively narrow. In case the price fluctuates a lot the Donchian channel shall be wider. Its major use, having said that, is designed for delivering signals for long and short positions. If the market trades above its highest n day high, then a long is identified. In case it trades under its lowest n day low, then a short is identified.
The Donchian Bands are worked out in straightforward formulas:
Upper Band = Highest High of X periods
Lower Band = Lowest Low of X periods
X will be the calculation period for the Donchian Bands.
The Donchian Bands mostly are used as a breakout signal - they define support and resistance and create entries as price breaks these levels. Since lows and highs usually correlate with support and resistance levels, this indicator is valuable in objectively defining support and resistance levels.
Nonetheless, it can also be used as a reversal signal - entering when price touches a band and reverses its direction. Prior to using the indicator in this way, confirm the validity of the psychological level by demanding a minimum of 2 touches at the level. This ensures that the signal is good and boosts its dependability.
My favored means of trading the Donchian Band is employing its middle band. The center band will be the average of the upper and lower band, and may also be used to evaluate trend. Entry signals are created in the following way: When price crosses the middle band from below - buy, and when price crosses from above - sell. It is usually a powerful signal when trend strength is confirmed (with support and resistance or combined with additional technical analysis tools).