The Donchian Channel indicator helps traders to identify bearish and bullish extremes with potential breakouts, reversals, breakdowns, or emerging trends. What’s more, it seeks the price highs and lows. Developed by Richard Donchian and at the beginning of the 80s, the indicator consists of several baseline elements that traders need to know in order to use the tool properly under real market conditions.
In this article, we will learn how the Richard Donchian indicator works and how it differs from Bollinger Bands. What’s more, you will find a secret pro tip with the most common mistake to avoid when using this instrument. Let’s get it started.
Donchian Channel Indicator Explained
As stated earlier, the indicator was developed by Richard Donchian. It was first introduced more than 20 years ago. However, it is still pretty popular with traders and investors of all levels. On the one hand, it can be pretty complicated for beginners right at once. On the other hand, it takes little time to clarify how the tool works and how to use it.
First of all, we will introduce the three major elements the indicator consists of. They are actually the three lines plotted by the moving average calculations:
- An Upper band (usually a 20-day high);
- A Lower band (opposite to high with a 20-day low);
- A Middle band – the average between low and high bands.
The middle band is the area where the indicator is formed.
What Can Donchian Channel Indicator Tell Traders?
The main aim of using the Donchian Channel indicator is to see the relations between the trading range and the current price over a given timeframe. It utilizes three major values we have discussed earlier to form a visual price map (the same way as Bollinger Bands. However, the two indicators are different).
As a result, traders are able to see the extent of bearishness or bullishness for a given timeframe. To identify the bullish energy, traders use the top line and vice versa – the bottom line helps to identify the bearish activity.