Richard Donchian created one of the best trading systems based on 4-week price channel breakouts and breakdowns. This system is widely used by traders on a daily, weekly and monthly basis. A breakout is described as the price exceeding the high or low of n-Number of days/weeks/months. Donchian method uses 20-period channels. This method works well in both up and down trends, but it evaluates poorly in side-ways markets as most breakout systems do. There are many other variation theories which are created using the Donchian Channel breakout method.

Donchain trading methods suggest entering new trades at retracement in the direction of the channel. Donchain also used a mid-channel between the “highest high and “lowest low,” and closed positions at mid-channels.

Trade:

1. Enter “long” or “cover short” when price exceeds the highest high of a 4-week range.

2. Enter a “short” when price falls below the “lowest-low” of a 4-week range.

Target: Most breakouts do not result in trends. However, protection of Donchian channels at the price range or fixed profit range is necessary. Exit trades when prices reach 1.5 to 2 Average True Ranges from the entry.
Stop: Protect trades at mid-channel level or when price trades at a 10-day “low” in a “long” trade or at 1 0-day “high” on “short” trades.

Trading Donchian Channel

Trading Donchian Channel

The example above illustrates a Donchian Channel trading system from the daily Russell Emini (ER2) chart. In mid May 2006, ER2 triggered a “short” trade as it closed below the 4-week Donchian price channels at 755 levels. The Average True Range (ATR) in mid May was 12 points.

  1. Enter a “short” trade below the low of the breakdown bar at 754.
  2. Place a “stop” order at mid channel above the trade entry bar.
  3. Set targets about one to two ATR levels from the breakdown levels.

Trading Donchian Channel

Trading Donchian Channel

The example above illustrates a Donchian channel from the Johnson and Johnson (JNJ) daily chart. A 4-week Donchain channel is plotted on JNJ’s daily chart. In late July 2006, a long signal was triggered when JNJ closed above the 4-week upper channel at $62. The Average True Range (10 period) for JNJ was 0.85 cents.

  1. A “long” trade was entered above the breakout bar’s high.
  2. A “stop” order was placed at the mid Donchain channel line and used as a trail stop.
  3. Targets were either set at fixed ATR lengths or used the center Donchian line as the trailing stop. The target was achieved around $64 using a center line as the trailing stop.