Donchian Channel Momentum Strategy

Introduction to the Donchian Channel Momentum Strategy

The strategy to be discussed is a simple strategy using the Donchian Channels indicator. Donchian channels are moving average derivatives which are used to plot the highs and lows of price action with a view to trading the trend.

Indicators Used:

This strategy uses the custom Donchian channel indicator, as well as a modified version of the Relative Strength Index (RSI). The role of the RSI is to provide confirmation for the momentum of the price action.

In addition, a template file will be provided to enable all indicators and settings for this strategy to be loaded to the chart automatically so you do not have to keep resetting the parameters for this strategy. The template file is included in the zipped folder which contains all indicators for this strategy. You can download the two zipped files by clicking here and here. Two moving averages which will serve as trade filters along with the RSI indicator are also added to the mix. These are the 20-period linear weighted moving average applied to the first indicator’s data, and the 100-period linear weighted moving average applied to the close.

Once you unzip the folders, go to the MT4 platform, click on File -> Open Data Folder -> Templates to install the template file here, then go back a step, click on MQL4 -> Indicators to install the customized RSI indicator and the Donchian channel indicator in that folder. Restart your MT4 platform and then load he template file by clicking on Charts -> Template – > Don 1 (the name of the template file).

You are now set to trade the strategy.

The Strategy

This strategy is hinged on the breakout system with the RSI and moving averages serving as filter. If you recall our lesson on the RSI as an indicator, you will remember that we said that figures above 50 are bullish until the price reaches the overbought zones and values below 50 for the RSI are bearish until the line gets to oversold areas.

Trend confirmation is obtained from the direction of the moving averages, especially the 100-period moving average. Please note that there are three Donchian channels plotted. You are not to use all of them at once. You should select the time frame (short, medium or long term), choose the appropriate Donchian channel and make the trade.

For short term trades, usually taken on the hourly chart, delete the 60-period Donchian channel and use the 10-period and 20-period channels.

For longer term trades (4-hour and daily charts), delete the 10-period Donchian channel and use the 20-period and 60-period channels.

Long Trade
The long trade is made when the following parameters are fulfilled:

  1. 100-period MA is pointing upwards.
  2. RSI is above 50
  3. Price has broken above the Donchian 20-period channel.

Stop Loss and Take Profit Settings

The trade is closed manually when the price action turns down and breaks the Donchian 10-period channel. The stop loss for the trade is set below the 100-period moving average. See sample snapshot below:

Don_long

Focus on the magenta coloured Donchian 20-period indicator. Notice that price action has broken above it, and that the RSI line (green colour in indicator window) is above the 50 mark and has broken through the upper line of the dynamic zone in the indicator window (brown colour). The 100-period moving average has started to point upwards. This is where the long trade is performed. Once price turns down and breaks the upper line of the 10-period Donchian channel (yellow colour), this is the exit zone.

b) Short Trade

The next example is that of a short trade. Here, we use a daily chart, meaning that we will delete the Don 10-period channel. We will look for where price breaks below the lower border of the Don 60-period channel,, with RSI <50 and the 100-period linear weighted moving average pointing downwards.

Don_short

On this daily chart of the EURUSD, we can see that the price action has broken the lower border of the white-coloured longer time period Donchian channel, which in this case is the 60-period Donchian channel. We also see that the RSI is at the 33 mark, supporting the trade direction. The 100-period linear weighted moving average is also pointing downwards. Having confirmed that the trade will most likely go south, the trader is to wait for a brief pullback to the broken Don 60-period channel and initiate a short trade from that point, following the trade until the exit position described below.

Stop Loss

The stop loss here will be set above the broken lower border of the 60-period Donchian channel since this is where the previous support lies.

Take Profit

The Take Profit is set to the area where the price action turns upwards and breaks above the magenta coloured Don 20-period channel line. These are all shown on the snapshot above.

Conclusion

The chart template file throws up a lot of lines and indicators. Whenever you want to look for a trade setup, you can use the Ctrl + I function to call up the indicator editing tool, then delete the lines that are not needed so that the chart can be clear enough for you to look for the trade entries that are relevant at that time. When you want to look for the reverse, simply reload the template and delete the necessary lines as needed. Practice the strategy on demo before applying it to a live account.

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