Description
The donchian channel is a volatility indicator, that calculates the recent price range using the recent high and low prices. The donchian channel is displayed as high and low bands (creating a channel containing the prices), and therefore it looks similar to other volatility indicators such as Bollinger Bands. However, the donchian channel is different in that it uses a simple calculation using only the recent high and low prices (rather than standard deviations or other indicators). The donchian channel is displayed with the price bars, and is the green and red lines (green for the high, and red for the low) in the example chart.
Calculation
- Description: The donchian channel is a calculation of the highest high (HIGH) and lowest low (LOW) over a specific number of previous high and lows (H and L).
- Calculation:
HIGH = Highest(H1, H2, H3, H4, ... Hn) LOW = Lowest(L1, L2, L3, L4, ... Ln) - Example:
HIGH = Highest(100, 105, 103, 104, 105) = 105 LOW = Lowest(96, 98, 97, 98, 99) = 96
Trading Use
As with other volatility indicators, and especially channel indicators, the donchian channel is usually used to identify a break out of a price range, or a continuation of a price range. For example, when prices break outside of the donchian channel, a possible break out might occur, but when prices are contained within a donchian channel a possible reversal might occur.
Donchian channels are not usually smoothed, so they react immediately to changes in the highest high and lowest low. This means that prices will rarely be outside a donchian channel, even during a break out of a price range, because the donchian channel will move to the new high or low on the next bar or candlestick. The example chart shows a price range followed by a break out of the price range, but as described above, the prices are primarily contained within the donchian channel.
