To a newbie forex trader, price charts are nothing but a chaotic mess—a code of sorts that needs a lifetime to decipher. Quite frankly, this is true. If you have untrained eyes, you will not make sense of a price chart. However, if you are a veteran trader, the kind that has invested in reading charts, a forex chart can help you decode an orderly pattern in the middle of the chaos. It can tremendously increase your confidence in trading and enhance your chances of making huge returns on your trades.
Contrary to common belief, the trend channel strategy isn’t complicated. There are tons of articles on forex blogs about this strategy. With a good grasp of the basics of trading channels and a profitable trend-following indicator, the sky is the limit for you. This guide will introduce the Donchian channel indicator—one of the best forex channel indicators.
The Donchian Channel Explained
The Donchian channel, named after the finest trader Richard Donchian (one of the pioneers of technical analysis) is a simple trend channel strategy. Basically, it plots two lines on a forex chart:
- The first line denotes the highest high over a set time frame
- The second line denotes the lowest low over a set time frame
Essentially, a trader makes a decision about the appropriate time frame to go with, the default period being 20 days.
The Formula of the Donchian Chanel
This trend channel indicator simply utilizes a user-defined period number and calculates both the upper and lower bands. Then it plots the two lines based on its formula which states that:
- The upper line refers to the highest price for the previous n period
- The lower line refers to the lowest price for the previous n period.
According to this channel indicator, the default value for n is 20 in MT4 but you are free to place whatever value as you please. Note also that there are certain Donchian channel indicator versions that can plot a third line. This line usually denotes the mean of the upper and lower lines and is often referred to as the centerline.
How to Use the Donchian Channel Trend Indicator
Before you enter into the world of technical analysis, realize that no matter what you do, you will never attain a 100% in all your breakouts. However, you can make use of this channel trading strategy to enhance the quality of your trades through the following steps:
Step 1: Determine the Trend
The first and most important thing to do is to determine the trend. This principle stands whether you are dealing with a bearish or bullish chart or a ranging one without any trend. This is straightforward for seasoned traders but beginners might find it quite tricky. To help point you in the right direction, examine your horizontal lines. Do the bottom ones keep getting higher or do the recent horizontal green line still tops the major horizontal green line? If you answered a resounding yes to both questions, you have a bullish trend. If the chart has highs symbolized by red lines plummeting with each passing minute, consider it as a bearish trending chart.
Step 2: Wait For the Expansion of the Market
Obviously, you don’t want to enter the market blind after you’ve determined the trend. Well, theoretically speaking, you could actually pull this stunt but that wouldn’t guarantee massive profits for you. How then do you determine symptoms of trend resumption?
Once the price drops below the middle blue line over the contraction phase, sit tight and wait for to close back above it using a candle. While at it, don’t utilize just any candle: use a big long one that indicates there’s enough force at the tail end of the shift in direction.
Step 3: Setting Up the Trade
How you set up your trade determines whether you’ll be successful with the Donchan Channel Indicator or not. Here are a few suggestions of what to do with your setup:
- Entry: Enter only after the breakout candle has closed
- Stop loss: Place it a few pips lower than the breakout candle
- Exit: Exit immediately after the closure of a candle located below the blue line
How Donchan Indicator helps you become a better trader
There’s a reason many seasoned traders agree that the Donchian Channel Indicator is one of the best forex channel indicators in the market. If you meticulously study the channel indicator, it can give you a trading edge. You’ll learn the following elements:
- Market volatility: By plotting highs and lows, this trend channel indicator allows forex traders to establish the distance price can travel. This is referred to as volatility. Many successful traders understand that they cannot make any money without volatility.
- Market contrasts and expands: Another important thing a Donchian Channel shows you is contraction and expansion market phases. Contraction phases are represented by a narrow Donchian Channel while expansion phases are represented by a wide Donchian Channel. This information is highly valuable as it helps you know when rapid price movements are bound to occur.
- Short-term range: Again by plotting highs and lows, this trend channel strategy technically plots the range over the last 20 periods. Although this knowledge isn’t useful for long-term traders, it certainly is pure gold to short-term traders.
- Direction of the Trend Based on Price Action: Perhaps the most important information you get from this trend channel indicator is the trend’s direction based on price action. One of the effective ways you can use to determine trend is through higher highs and lower lows. Charts that display higher highs and higher lows are often bullish trending charts. Those displaying lower highs and lower lows are bearish trending charts. It is, therefore, safe to say that a Donchian indicator helps you analyze whether a chart is considered trending or not.
When it comes to the trend channel strategy, several channels can be termed as the best forex channel indicators but honestly, very few come close to the Donchan Channel. It makes trading simple by exposing traders to different market elements so that they can place profitable trades. If you are new in the forex market, this indicator is worth considering.