Donchian Channels were introduced by Richard Donchian, a pioneer in the field of trend following. The Donchian Channel is a simple trend following breakout system. The Donchian Channel works well in trending markets, but doesn't work well in a sideways channel. The signals derived from the Price Channel are based on the following basic rules:
- When price closes above the Donchian Channel, buy long and cover short positions.
- When price closes below the Donchian Channel, sell short and liquidate long positions.
The Donchian Channel indicator is not meant to catch tops or bottoms, only trends. Trend traders may want to extend the standard 4 week period to 8 weeks in order to wait for significant trend signals, while others may shorten the period to a more sensitive 1 or 2 weeks for liquidation purposes.
Above is a Daily Chart of Microsoft (INTC). The upper band of the Donchian Channel is show in purple, with the lower band in blue and the middle band in gold.