The Donchian Channels Indicator belongs to the family of breakout indicators. Crypto traders use it to identify low and high extremes that could lead to reversals, trends, breakdowns and breakouts.
The indicator was developed by Richard Donchian, who was a trader known for his simple “follow the trend” trading style. Naturally, his indicator is the perfect trading tool for exactly that approach.
Structure of the Donchian Channels Indicator
The Donchian Channels Indicator has three lines main lines. These three lines show the channel’s low, high and center. The low represents the lowest reading over the specified period, the high line indicated the highest reading over the same period, and the center line is created by subtracting the highest high from the lowest low and dividing it by two.
The more volatile a market is, the wider apart the two channel extremes are.
While this indicator looks similar to Bollinger Bands, the main difference is that the Donchian Channels Indicator uses the highest high and lowest low over a specified period and Bollinger Bands use the simple moving average plus/minus the standard deviation of the price for a time period multiplied by 2.
With the Donchian Channels Indicator, we can compare the current price with ranges over the preceding period. The channels drawn on the price chart indicate the strength of the current market, varying from bearish, bullish or ranging. It is one of the simpler indicators used for technical analysis and a good tool for both beginner and advanced crypto traders.
Trading crypto with Donchian Channels
In general, there are two types of crypto trading strategies: trading breaks of the center channel line, or trading breakouts or breakdowns of upper or lower channel lines
The first crypto trading approach uses the Donchian Channels Indicator to indicate a move to buy/sell 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 BTC/USD price chart below we see the BTC price almost instantly creating a new channel high, as soon as the price crosses the center line upwards, indicated a reverseal from a bearish to a more bullish market.
With the second trading strategy, crypto traders are looking for signals to buy or sell an asset. Signals are generated every time the channel extremes make a new high or low.
For example, a move is indicated once the new 20-day high has been reached and the green line has made the move up equal to the new high. The indicator also sends a sell signal when the price pushes the existing channel’s low further lower, indicated a bear market.
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