Bands and Channels (Donchian Channels)

[dpaterso]

In my ‘quest’ to eliminate the ‘drawbacks’ (‘drawdowns’ is probably a better word if you are able to excuse the pun) inherent with Parabolic SAR I have been doing a lot of ‘playing’ with EMA’s, SMA’s, and the like.

During this ‘quest’ I have ‘stumbled’ along ‘price channels’ and some associated ‘price channel’ indicators and/or trading methods. These include ‘Envelopes’, ‘Linear Regression’, ‘Keltner Channels’, ‘Donchian Channels’ and ‘STARC Bands’ to name but a few.

If you want to read more about some of the above then take a look at this link:

Capture Profits Using Bands And Channels

Of the above I found ‘Donchian Channels’ to be of extreme interest.

Essentially what the ‘Donchian Channels’ represent are ‘price channels’ or (my interpretation) support and resistance for a given period.

In other words (as I understand it) a ‘Donchian Channels’ indicator will draw lines representing the highest high and lowest low of the preceding number of bars for a given period. The middle line represents the difference between the two.

None of my trading platforms provide ‘Donchian Channels’ as an indicator so I ended up ‘coding’ my own ‘version’ and I think I’ve come pretty ‘close’ as it were (see attached chart).

Having ‘coded’ my own ‘version’ of ‘Donchian Channels’ I then needed to formulate a method of trading with them and this is what I have come up with:

For the purposes of this demonstration I am using 4 periods on a daily chart of EUR/USD.

Essentially (the way I see it) you place a buy order at the current value of the upper channel and a sell order at the current value of the lower channel.

Let’s say that the buy order gets executed first.

You continue to ‘track’ the upper and lower channel placing buy orders and sell orders at the current value of the channels on a daily basis.

This will result in the following:

As the price keeps moving up (in this example - remember our first buy order got executed first) you will be opening new long positions at or above every resistance level as indicated by the the indicator resulting in multiple long positions.

If (or rather when) the price reverses your nearest sell order will get executed resulting in a take profit and a stop and reverse.

As the price now keeps going down you will be opening new short positions at or below every support level as indicated by the indicator resulting in multiple short positions.

Obviously the number of lots has to be tracked on the way up and the way down i.e. the opposite order should be the number of current lots open + 1.

In other words: let’s say that by the end of the long rally you ended up with 10 long positions. Your corresponding (and closest) short order would be for 11 short positions i.e. you would be taking the nett profit on 10 long positions and opening a single short position when the price reverses and so on and so forth.

The ‘method’ SHOULD work in a ranging market as well. Why? Because you are in effect always covering your exisiting positions + 1 additional position.

In a ranging market you will obviously not make profit on more than one lot at a time though BUT you will NEVER have to write off any capital i.e. you should NEVER have to take a loss using this method. The only thing that you have to ensure is that you have LOADS of free margin and/or a highly leveraged account in case you get stuck in a range for an extended period of time. Another way of protecting yourself in a ranging market is to use what the brokers refer to as ‘hedging’ (which is not quite the correct term as we know) BUT what it means is that if you get stuck in a range you would effectively have multiple long and short positions open on the same pair + 1 position so that when the pair eventually does break out and start to trend you take profit on that 1 position and start adding as detailed above.

Now - this is just something that I ‘came up with’ over the past couple of days and I am posting it here for some comment and any thoughts on the ‘method’.

I have started trading it today (live) so I’m interested to see what happens.

What do you people think?

Ideas? Thoughts? Drawbacks? Pro’s? Con’s?

[pip_my_ride1]

Your system has some merit as it adds to positions when you’re already winning and also in the direction of the trend. This would mean that a strong trend will see you make quite a bit of profit in trades. However, i’m not so sure about trades in ranging or choppy markets. How do you come out without losses? Are you able to post a chart as an example?

Also, I was wondering why you didn’t get stopped out soon after you entered the long trade as shown on your chart, as there was a long red candle that hit the opposite band. Maybe, i’m not reading clearly, but any help will be appreciated.

Cheers

[tymen1]

To Dpaterso

Thank you for your post on channels and envelopes.

They are a staple diet in my trading with candlesticks.

All these envelopes are probability bands, and, as such make more sense to me for trading. They do not dictate when to enter, but rather give and indication of where price is likely to go.

You can then act on these indications.

Congratulations also on reaching FX men honourary member status.

[rhodytrader]

Not to rain on anyone’s parade here, but it tends to be more the trading approach than the trading method which determines the length and depth of drawdowns. Donochian, moving averages, SAR, and all of that sort of stuff fall into the category of trend following approaches. As such, they are all subject to significant drawdowns. It’s a simple function of the fact that they tend to be wrong more often than right, though when they are right the gains can be spectacular. Low drawdown systems feature higher win rates, but also generally much lower winner/loser ratios.

[dpaterso]

I’m surprised!!!

Hello everyone.

I posted the initial message ages ago and I thought it had ‘died a horrible death’.

I only traded my ‘Donchian Channel Indicator’ once or twice but to be honest it was bringing me no closer to ‘improving’ Parabolic SAR so I ‘gave it a miss’ as it were.

Having said that though (from what I read) channel trading is (apparantely) one of THE MOST PROFITABLE trading methods and there are LOADS of different ‘channels’. I was ‘getting quite into’ ‘channels’ at one stage (when I posted the first message) and I do believe they have merit (even on their own but that’s just me).

Like I said I never ‘pursued’ any of this but learned a great deal. If you want to discuss any of this further feel free.

John is right I think. In other (my) words: with discipline and small stops you should be able to be quite profitable if you’re interested. From what I can remember (especially with Keltner Channels) more often than not when the price closed outside of one of the Keltner Channels it then traded to the other channel BUT there were also MANY trades where the price just kept trading outside of the channel and then reversed so if you did not have good money management i.e. small stops you probably would have been ‘eaten alive’ and, at best case, still have an account when the price did indeed trade to the other channel. Having said that these channels are better, in my opinion, than Bollinger Bands for the simple reason that they don’t rely on a standard deviation from the price but are rather more ‘in tune’ with the latest prices (if that makes sense). Having made THAT statement there is nothing really ‘magical’ nor ‘mystical’ about any of them i.e. they are not much more than ‘EMA’s on steriods’ (for want of a better analogy)!!!

Tymen makes a good point though: I never thought of them as being a ‘confirmation’ for candlestick trading. Now that’s got merit!!!

Edit:

Actually I saw an interesting use of Bollinger Bands AND Keltner Channels. As you know you can use Bollinger Bands to see when the price has narrowed and a breakout is ‘due’. The problem with Bollinger Bands is (and I’m quoting here): ‘how narrow is narrow’? But if if you overlay the Keltner Channels over the Bollinger Bands and couple it with a momentum indicator then you’ve got ‘juice’ i.e. you wait for the Keltner Channels to move inside the Bollinger Bands and take a trade on the first break of the Bollinger Bands by the Keltner Channels in the direction of the momentum indicator i.e. long if momentum is greater than 0 and short is momentum is less than 0. Try it. Have a look. From what I remember on the very short timeframes this gave you quite a few trades per day BUT the ‘key’ is to WAIT for the setup not ‘second guess’ it and have a ‘profit target’ of a few pips ‘carved in stone’.