Trading

How to Apply Donchian Channels Indicator to crypto trading

September 4, 2019


Belonging to the family of breakout indicators, Donchian Channels is used to identify high and low extremes that may lead to reversals, breakouts, breakdowns and trends. Developed by futures trader Richard Donchian, this indicator can be applied to crypto trading and works in a similar way to Bollinger Bands, as it is comprised of three separate lines.

Structure of the Donchian Channels Indicator

Donchian, a trader himself, has been known for his simple trading approach - follow the trend. Once, he was referring to a copper chart when he commented: “The fundamentals are supposed to be bullish in copper, but I’m on the short side now because the trend is down”. It is exactly this sentence that perfectly explains not just Donchian himself, but his famous indicator as well. 

The three lines show the channel’s high, low and center. The high represents the highest high over the predetermined period, usually set at 20. The low is the opposite i.e. the lowest reading over the last period, while the center (median) line is calculated by subtracting the highest high print from lowest low print and dividing by 2. The wider two channel extremes are, the more volatile the market is and vice versa. 

In technical analysis, for crypto trading or otherwise, print refers to the drawing of a candlestick pattern on a technical analysis price chart. As price charts are usually time-based each bar prints as it forms and becomes printed at the end of the selected date interval.

Although similar to Bollinger Bands, Donchian Channels Indicator is different in a way that it doesn’t require user input for volatility. Moreover, it uses the highest high and lowest low over X periods while Bollinger Bands, on the other hand, uses a simple moving average for X periods plus/minus the standard deviation of the price for X periods, times 2.


Donchian Channels example on price chart
Donchian Channels example on price chart


In essence, Donchian Channels compare the current price with ranges over the previous (set) periods. The channels indicate the strength of the current market - bullish, bearish or ranging. It is considered to be one of the simplest trading indicators out there, applicable to all markets, including the cryptocurrency market. To apply this indicator, simply go to SparkDEX and choose the indicator from the drop-down list of available indicators.


Apply Donchian Channels Indicator on SparkDEX
Apply Donchian Channels Indicator on SparkDEX


Using the Donchian Channels Indicator for crypto trading

In general, there are two types of crypto trading strategies developed based on the Donchian Channels Indicator: trading breakouts or breakdowns of upper or lower channel lines, or trading breaks of the center channel line in both directions. If the market is bullish and the trend is up, the upper channel line is pushed up as well and vice versa. If the price stays away from the upper line, it will stay at the previous 20-day high, (in case 20 is the set value), before dropping soon, as seen in picture 3 below.


 Trading strategies: using the Donchian Channels Indicator 
 Trading strategies: using the Donchian Channels Indicator 


By using the first trading strategy, crypto traders will be looking for signals to buy the cryptocurrency once the new 20-day high has been made and the green line has made the move up equal to the new high and vice versa. On the other hand, any move below the red line (the lowest point over the last 20 days) means the trend is bearish as the price pushed the existing channel’s low further lower. So, a signal is generated every time the channel extremes make a new high or low.

The second crypto trading approach assumes buying or selling a move above or below the center line. This approach is especially profitable if the crypto price had been trading near the channel’s extremes,  and is now changing the trend direction and aggressively moving in the opposite direction. In the price chart below, we see a great example of how to apply Donchian Channels Indicator in the perfect manner. 


Bitcoin price chart: Trading the Center Line of the Donchian Channels Indicator
Bitcoin price chart: Trading the Center Line of the Donchian Channels Indicator

 

We see that the price trends near the channel lows before starting to move higher. The moment the price crosses the center line upwards is a signal that the trend has changed and this may lead to a more bullish market. In this particular case, the bitcoin market almost instantly created a new channel high, at a price near $2,000 higher compared to the channel’s center line. 

A reliable tool for trading all crypto, any time period

As another “ride the trend” indicator, Donchian Channels is a reliable tool for identifying the trend of crypto prices and generating trade signals, usually tied to reversals, breakouts and breakdowns. Comprised of three simple lines, it represents a simple but powerful indicator which can be applied to trade all cryptocurrencies over all time periods. 

Furthermore, the width of the channel also indicates the volatility of the market, which again generates more useful information for trading crypto.

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