Donchian Channels

Donchian Channels are one of the simplest indicators in trading. The upper band is the highest high over a set number of periods, the lower band is the lowest low, and the middle line is the average of the two. Developed by Richard Donchian, a pioneer of trend following in the mid twentieth century, they define breakouts with no calculation beyond finding a high and a low. They became famous through the Turtle Traders of the 1980s.

The formula#

Upper band = Highest high over n periods
Lower band = Lowest low over n periods
Middle line = (Upper band + Lower band) ÷ 2

A common setting is 20 periods, roughly one trading month on a daily chart.

Why breakouts of the channel matter#

A new 20 day or 55 day high means price has moved beyond its recent range, which is often how trends begin. Trend followers do not try to predict which breakouts will turn into big trends. They take them all with strict risk control, accepting many small losses in exchange for occasional very large gains. See Trend Following.

The Turtle Trading rules#

In 1983, commodity traders Richard Dennis and William Eckhardt trained a group of novices, nicknamed the Turtles, to trade a fully rule based trend following system. Former Turtle Curtis Faith later published the rules. In simplified form:

They also added to positions as trends developed and limited total risk across correlated markets. The rules are well known now, and simple versions have performed much less well in some later periods, but the principles of breakouts, volatility based sizing and letting winners run remain central to trend following. See Volatility and ATR-Based Sizing.

Other uses#

• Trailing stops: for a long position, exit on a break of the 10 or 20 day low.
• Trend direction: price near the upper band and the bands rising suggests an uptrend.
• Range identification: flat bands and price rotating inside them suggest a range.
• Volatility gauge: the channel width shows how wide the recent range has been.

Strengths and weaknesses#

Donchian vs Keltner and Bollinger#

Donchian Channels track the actual extremes of price, so price can never close outside them on the same period it sets a new extreme. Keltner and Bollinger bands are statistical envelopes around an average. Donchian Channels are therefore best for breakout systems, while the others suit volatility and mean reversion analysis. See Keltner Channels and Bollinger Bands.

Common mistakes#

• Expecting most breakouts to succeed. Trend following relies on a minority of large winners.
• Abandoning the system after a string of losses, which is normal for breakout strategies.
• Using short lookbacks on noisy, low timeframe charts.

Frequently asked questions#

What are Donchian Channels?#

Bands showing the highest high and lowest low over a set number of periods, with a middle line halfway between.

What were the Turtle Trading rules?#

A trend following system that bought 20 or 55 day breakouts and sold on breaks of 10 or 20 day lows, with ATR based stops and position sizing.

Are Donchian breakouts still profitable?#

Breakout trend following can still work, but returns vary greatly over time and simple published versions have weakened. Testing and strict risk control are essential.

Sources#

• Wikipedia, Donchian channel
• Wikipedia, Richard Dennis