What it measures
The channel records the extremes of a window of bars: how high the price went and how low. Its width is the whole range the market covered in that time.
The lines move in steps. The upper line rises when a bar makes a new high for the window, and it falls only when the bar that set it leaves the window. Between those events it is flat, which gives the channel its staircase look.
It is named after Richard Donchian, a twentieth-century futures trader associated with rule-based trend following. A rule built on it, buying a new 20-bar high and selling a new 20-bar low, is among the oldest written trading rules, and was part of the method taught to the group of traders known as the Turtles in the 1980s.
How it is calculated, step by step
- 01
Choose a length, N.
The number of bars the channel looks back over. N is usually 20.
- 02
Upper line: the highest high of the last N bars.
On this page the latest bar is included, so a bar can never be above the line: at most it sets it.
- 03
Lower line: the lowest low of the last N bars.
The same window, the other extreme.
- 04
Middle line: halfway between.
Middle = (upper + lower) ÷ 2. It is not an average of prices; it is the midpoint of two of them.
Programs differ on whether the latest bar is in the window. A breakout rule needs yesterday’s channel, made from the N bars before the latest one, so that today’s price can be compared with it. With the latest bar included, as here, a new extreme shows as the bar setting the line.
A worked example, by hand
Four bars, written high / low: 10 / 8, then 12 / 9, then 11 / 9, then 13 / 10. Length 3.
- Bar 3: the highs of bars 1 to 3 are 10, 12, 11, so upper = 12
- The lows are 8, 9, 9, so lower = 8; middle = (12 + 8) ÷ 2 = 10; width = 4
- Bar 4: the highs of bars 2 to 4 are 12, 11, 13, so upper = 13: bar 4 set it
- The lows are 9, 9, 10, so lower = 9; middle = (13 + 9) ÷ 2 = 11; width = 4
The lower line rose from 8 to 9 although no bar did anything at 9 on bar 4. The bar with the low of 8 left the window. Half of what moves a Donchian line is old bars dropping out.
The numbers in this example were chosen to be easy to add up. They are not prices of anything.
How people read it
- A bar that sets a line. A new high for the window is called a breakout upward; a new low, a breakout downward. It reports that the price is at its highest, or lowest, for N bars.
- The width. A wide channel means the price has covered a lot of ground; a narrow one, that it has been confined.
- The middle line. The price above it is in the upper half of its recent range.
- As trailing levels. The lower line is used under a rising price as a level that only rises while new lows are not made, and the upper line the other way.
What it cannot tell you
- It cannot say that a breakout will continue. Every sideways market ends with a new high or a new low, and so does every false start.
- It cannot react smoothly. One extreme bar sets a line for the next N bars, and the line jumps on the day that bar leaves, whatever the price is doing.
- It cannot see closes. It is made from highs and lows, so one brief spike defines the channel as much as a bar that closed there.
- It cannot tell you which length is right. Twenty bars is a convention.
Common mistakes
- Treating a new high as proof of a trend. It is the definition of a new high and nothing more.
- Comparing a bar with a channel that already contains it, and wondering why the price never breaks out.
- Reading the flat stretches as support or resistance that the market is respecting. A line is flat because nothing has exceeded it yet.
- Ignoring the cost of a rule that buys every new high. In a range such a rule buys near the top and sells near the bottom, repeatedly.
Questions people ask
- How is a Donchian channel different from Bollinger Bands?
- Bollinger Bands are a moving average with lines a set number of standard deviations either side: every part is a calculation on closes. A Donchian channel is simply the highest high and the lowest low of the window: two prices that traded. The Donchian lines move in steps; the Bollinger lines move smoothly.
- Does a break of the Donchian channel mean a trend has started?
- It means the price has made its highest high, or lowest low, for the length of the window. Trends begin that way, and so do many moves that fail within a few bars. The channel cannot tell the two apart at the time.
- What length should a Donchian channel have?
- There is no right length. Twenty bars is the usual default, and longer windows such as 55 are also well known. A short channel is set by small swings and is broken often; a long one is broken rarely and late.
The words on this page
An indicator is arithmetic on prices that have already happened. It describes what a price did; it does not predict what a price will do. The chart on this page is invented: a seeded random walk, not a market. This page is an explanation for study. It is not advice, a recommendation or a forecast, and nothing an indicator shows says anything certain about what a price will do next.