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Donchian channel (DC) Forex trading system

Author: Martin Moni
Martin Moni
All publications of the author

I first encountered the DC marker as I was researching some of the most famous traders in history. Lately, it has become a very popular marker that is used across many financial markets including stocks, futures, commodities and now the Forex market. Therefore, the DC Forex exchange style is primarily based on the DC marker because it has already proved to be a reliable marker for decades.

About the DC marker

In this case, Richard Donchian created the DC marker; so naturally, the proprietary trading marker was named after him. His interest in the markets was initially personal out of a fascination with the financial markets. It is used primarily to identify trends and follow them effectively, which is why the creator was eventually called the ‘father of trend following’. Today, many of the trend following strategies are based on his work, including the DC marker itself. Because the marker is a tool for following long-term trends, the DC Forex trading strategy is also more suited to day traders rather than scalpers. (Learn the: 10 rules of how to earn money with scalping)

On the Forex charts, the DC marker appears as three bands that move along with the candlesticks. The two main bands, top and bottom, are formed by taking the peak and trough prices for a specified period of time in the past. The default value after you add the marker to the Forex trading platforms is usually 20 periods, but you can modify this value depending on your trading style. Then the middle band is calculated by taking an average of the two aforementioned values. Together, the three lines/bands form the Donchian DC. (Do you know: How to choose a trading strategy?)

How to use the DC marker

You may already notice that the DC marker is closely related to MAs, which is another tool on which the creator of the marker relied heavily. Anyway, the main difference between the DC marker and MAs is how it is used. (Learn this: Forex strategy on based on MAs)

Spotting trend breakouts

Unlike how we use MAs by spotting the crossover, we simply wait on the direction of either of the main DC bands. Whenever the DC is broken, then that means there may be a breakout in the markets presenting a trading opportunity. Take the example below of a chart by one of the top ECN Forex brokers.

In the above chart, I’ve used arrows to show how the DC marker could have been used to identify the direction of the trend. At first, the Donchian DC had been formed following a strong downtrend and the markets were ranging. Afterwards, the DC was broken when the bands started moving upwards. This was the signal to buy into the markets since the previous 20-period high had been broken. After a strong move to the upside, the trend seemed to reach a climax, and the DC evened out representing a ranging market. Soon thereafter, the DC was once again broken to the upside and the uptrend resumed. It is only after the DC was broken to the downside that the trend was again reversed and began going down.

This is the first and main use of the DC marker – spotting the breakout. However, you should not just assume that the trend has changed until the bands of the DC marker clear the DC. For example, there was a momentary decline in prices around the middle of the chart above. Nevertheless, the trend did not reverse because the prices did not break blow the lower band of the DC marker. It was only a correction in the markets. Remember, Donchian himself urged for a cautious approach and it usually worked. (Learn about: The Elliot wave theory and how to use it)

Identifying the S/R levels

As you may well know, breakouts only occur at S/R levels in the markets. Therefore, identifying these points on the charts is very crucial. Not only will they help you spot the breakouts, but also present opportunities to trade fakeouts and ranging markets. The DC marker can also help with this because the peak and trough prices within specified time periods are usually around S/R levels. Since the DC marker takes the peak and trough values from specified periods, then it can also be used to identify S/R levels. (All about: Identifying the false breakout trading strategy)

Even with a lot of experience, it may be difficult to accurately draw the S/R levels on the charts, but the DC marker will make the process easier. Trading platforms provided by all Forex trading brokers will have horizontal lines to mark these S/R levels. By simply tracing those lines on the Donchian DC, you can have yourself pretty accurate S/R levels to work with. (This is: How to draw S/R levels like a pro)

Knowing when the market is trending or ranging

Most people assume that it is easy to know whether the market is trending or ranging, but it’s not so simple. The markets may indeed be trending on the hour timeframe, but ranging on the daily timeframe. With the DC marker, though, you won’t be falling into this trap and falling for false signals. This is because the DC marker uses the peak and trough prices from a long period from the past. In this way, even on a lower timeframe, you can be reasonably certain about the movements on a longer timeframe.

What you need to know about the DC trading strategy

Before you can even begin using this trading strategy, you shall obviously need to know how to add custom markers to the MetaTrader 4 platform. Fortunately, we have already described the entire process in this link: How to launch an expert advisor on MT4.

Apart from that, you have to be aware of your own trading style. For example, if you prefer to trade long-term trends, then it’s better if you increased the period on the DC marker and vice versa. Also, if you are a cautious trader, remain patient until the prices have cleared completely off the DC before placing the trade. For a more aggressive approach, you can place your orders as soon as the DC is broken, but always remember to risk management rules.

 

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