Donchian Strategy
By Samantha Baltodano
TL;DR:
The Donchian strategy is a trading method that uses the Donchian channel, a tool that looks at the highest and lowest prices of a stock over a set period of time. It creates two lines, the upper band and lower band, that show where the highest and lowest prices were during those periods.
The simplest version of the strategy uses four rules to determine when to buy or sell a stock, based on the highest and lowest prices over a longer and shorter period of time. The strategy can be made more complex by adding a volatility filter or stop loss based on the Average True Range (ATR), helping investors make more informed decisions about buying and selling stocks.
What Is The Donchian Strategy?
The Donchian strategy is a way to help people make decisions about buying and selling stocks using a special tool called the Donchian channel.
This tool looks at the highest and lowest prices of a stock over a certain amount of time (usually 40 and 15-day periods). It then creates two lines called the upper band and lower band that show where the highest and lowest prices were during those periods.
At the simplest level, the Donchian strategy uses four rules to help people decide when to buy or sell a stock.
- If the high price of a stock is higher than the highest high on the longer period, the strategy suggests buying the stock.
- If the low price of a stock is lower than the lowest low on the longer period, the strategy suggests selling the stock.
- When it's time to close a position, the strategy looks at the highest high and lowest low of the shorter period to determine whether to sell or buy back the stock.
If you want to make the strategy more complex, you can add a volatility filter or a stop loss based on something called the Average True Range (ATR).
The volatility filter helps determine whether it's a good time to enter a trade based on the stock's recent movements. The stop loss helps people avoid losing too much money by exiting a trade when the stock's price moves against them.
By using the Donchian strategy, investors can make more informed decisions about buying and selling stocks. Depending on how complex they want to make the strategy, they can use different rules and tools to help them make the best decisions possible.
Example
Let's say you are interested in trading the stock of a company called ABC. You have decided to use the Donchian strategy to help you make investment decisions. You start by looking at the highest high and lowest low prices of the stock over the past 20 days. The highest high is $50, and the lowest low is $40.
Using the Donchian strategy, you would now create the upper and lower bands of the Donchian channel. The upper band is formed by the highest high value over the 20-day period, which is $50. The lower band is formed by the lowest low value over the 20-day period, which is $40.
Now that you have the bands, you can start using simulated orders to make investment decisions. Let's say the current price of ABC's stock is $45. According to the Donchian strategy, you would buy the stock if the price goes above the upper band, which is $50. You would sell the stock if the price goes below the lower band, which is $40.
A few days later, the price of ABC's stock rises to $55. This is above the upper band of the Donchian channel, so you would buy the stock. You would continue to hold the stock until the price falls below the lower band, which is $40. At this point, you would sell the stock.
Test The Donchian Strategy
Great news!
You can back test this exact strategy on historical data for any of your favorite symbols using TradingView.
This strategy has already been built and all you have to do is log in and take it for a spin. You can access this indicator here.
If you’d like even more options and variations of this indicator, check out all the scripts available for Donchian Channels here.
If you’re new to back testing and to TradingView, don’t worry. I created a step-by-step guide you can follow to begin testing the Donchian Strategy.
Summary
- The Donchian strategy helps people make decisions about buying and selling stocks using the Donchian channel.
- The channel looks at the highest and lowest prices of a stock over a certain amount of time and creates two lines called the upper and lower band.
- The simplest level of the strategy uses four rules to help people decide when to buy or sell a stock based on the highest and lowest prices during those periods.
- Adding a volatility filter or a stop loss based on the ATR can make the strategy more complex.
Donchian is just one of many strategies that Archaide automates. For a full list of strategies and studies available click here.
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