Donchian Channels and Example

What Are Donchian Channels?

Donchian Channels are three lines generated by moving average calculations that comprise an indicator formed by upper and lower bands around a midrange or median band. The upper band marks the highest price of a security over N periods while the lower band marks the lowest price of a security over N periods. The area between the upper and lower bands represents the Donchian Channel.

Career futures trader Richard Donchian developed the indicator in the mid-20th century to help him identify trends. He would later be nicknamed "The Father of Trend Following."

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The Formula for Donchian Channels Is:

UC = Highest High in Last  N  Periods Middle Channel = ( ( U C + L C ) / 2 ) LC = Lowest Low in Last  N  periods where: U C = Upper channel N =  Number of minutes, hours, days,  weeks, months Period = Minutes, hours, days, weeks, months L C = Lower channel \begin{aligned}&\text{UC = Highest High in Last }N\text{ Periods}\\&\text{Middle Channel} = ((UC+LC)/2)\\&\text{LC = Lowest Low in Last }N\text{ periods}\\&\textbf{where:}\\&UC=\text{Upper channel}\\&\begin{aligned}N=&\text{ Number of minutes, hours, days,}\\&\text{ weeks, months}\end{aligned}\\&\begin{aligned}\text{Period}=&\text{Minutes, hours, days, weeks,}\\&\text{months}\end{aligned}\\&LC=\text{Lower channel}\end{aligned} UC = Highest High in Last N PeriodsMiddle Channel=((UC+LC)/2)LC = Lowest Low in Last N periodswhere:UC=Upper channelN= Number of minutes, hours, days, weeks, monthsPeriod=Minutes, hours, days, weeks,monthsLC=Lower channel

How to Calculate Donchian Channels

Channel High

1. Choose the time period (N minutes/hours/days/weeks/months).
2. Compare the high print for each minute, hour, day, week, or month over that period.
3. Choose the highest print.
4. Plot the result.

Channel Low

1. Choose the time period (N minutes/hours/days/weeks/months).
2. Compare the low print for each minute, hour, day, week, or month over that period.
3. Choose the lowest print.
4. Plot the result.

Center Channel

1. Choose the time period (N minutes/hours/days/weeks/months).
2. Compare high and low prints for each minute, hour, day, week, or month over that period.
3. Subtract the lowest low print from the highest high print and divide by 2.
4. Plot the result.

What Do Donchian Channels Tell You?

Donchian Channels identify comparative relationships between the current price and trading ranges over predetermined periods. Three values build a visual map of price over time, similarly to Bollinger Bands, indicating the extent of bullishness and bearishness for the chosen period. The top line identifies the extent of bullish energy, highlighting the highest price achieved for the period through the bull-bear conflict.

The center line identifies the median or mean reversion price for the period, highlighting the middle ground achieved for the period through the bull-bear conflict. The bottom line identifies the extent of bearish energy, highlighting the lowest price achieved for the period through the bull-bear conflict.

Example of How to Use Donchian Channels

Image by Sabrina Jiang © Investopedia 2021

In this example, the Donchian Channel is the shaded area bounded by the upper green line and the lower red line, both of which use 20 days as the band construction (N) periods. As price moves up to its highest point in the last 20 days or more, the price bars “push” the green line higher, and as price goes down to its lowest point in 20 days or more, the price bars “push” the red line lower.

When the price decreases for 20 days from a high, the green line will be horizontal and then start dropping. Conversely, when the price rises from a low for 20 days, the red line will be horizontal for 20 days and then start rising.

The Difference Between Donchian Channels and Bollinger Bands

Donchian Channels plot the highest high and lowest low over N periods while Bollinger Bands plot a simple moving average (SMA) for N periods plus/minus the standard deviation of price for N periods X 2. This results in a more balanced calculation that reduces the impact of big high or low prints.

Limitations of Using Donchian Channels

Markets move according to many cycles of activity. An arbitrary or commonly used N period value for Donchian Channels may not reflect current market conditions, generating false signals that can undermine trading and investment performance.