The Right Tool for the Job
There are hundreds of financial analysis tools available to help investors interpret market data, identify pricing trends, and guide buying and selling behaviour. It is essential to use the right tool for the job.
Sometimes those tools are as complex as the data that they generate, like the various oscillators used to pinpoint market trends, and other times they are simple and straightforward like the Donchian Channels.
What are the Donchian Channels?
The Donchian Channels were developed by Richard Donchian sometime in the late 1940s, and early 1950s. Richard Donchian was known as the progenitor of the managed futures industry and was often called the father of trend following. Access the economic calendar for your trading strategies to see upcoming news events on Tradingview.
The Donchian Channels are a type of technical analysis tool known as a banded indicator. In other words, the tool uses values that fall into different ranges or bands to describe or predict various aspects about a securities market.Donchian Channels | Indicator Series Click To Tweet
The Donchian Channels consist of three bands:
- A high band
- A low band
- A middle band that is the median between the two
The Donchian Channels are calculated by taking a period of time (whatever period the user wishes) and noting the highest and lowest securities prices during that period. The highest price is the upper band, and the lowest price is the lower band. The average of the two values is used to establish the middle band.
What are the Donchian Channels Used For?
For investors, Donchian Channels serve a two-fold purpose:
- To detect the level of market volatility
- To detect periods of overbought and oversold securities.
The wider apart the upper and lower bands are, the more volatile the market it. Conversely, if the bands are narrow there is less market volatility.
If the security’s price exceeds the upper band, it indicates overbought conditions are present. If the price drops below the lower band, it indicates that the security has an oversold temperament.
Donchian Channels are also useful in confirming overall market trends, especially when they are used in conjunction with other financial analysis tools.
How Can You Use the Donchian Channels to Your Advantage?
Donchian Channels can be used to confirm market trends including bearish or bullish behaviour in securities prices. As long as the period used to calculate the channels is of sufficient size, it is easy to see overbought and oversold conditions over that period of time. By comparing those conditions against the level of market volatility, wise traders can use this data to better inform their investment behaviour.
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