Donchian Channels - Crypto Academy / S5W1 - Homework post for @ lenonmc21

in hive-108451 •  2 months ago  (edited)

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INTRODUCTION:

Technical indicators has come a long way and has proven to be good technical analysis tool. The concept of technical analysis is the use of past data of an asset to forecast possible price movement.

Technical indicators serves varying purposes including dictating trend, measuring trend strength, dictating reversals, identifying entry and exit points and more. Some indicators are multifunctional, performing more than a task; others may be single task.

After the lecture of professor @lenonmc21, our attention is drawn to Donchian Channels. In this post, I will take a look at this technical indicator.

Q1

"Explain and define in your own words what the Donchian Channels are?"

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DONCHIAN CHANNELS .

Donchain channels are trend following indicators useful to identifying possible breakouts and retracement of a tradable asset being analyzed. The name Donchain are derived by the name of it's developer Richard Donchain who happened to be a notable commodity and futures trader.

Because of the construction of the Donchain indicator it works better with candlesticks making it easier to map out information supplied by the indicator. This is because with candlesticks it will not be difficult obtaining the open, the high, the low of a period and these are the information needed by the Donchain indicator to function.

HOW IT WORKS

Because the Donchain channels is a trend following indicator, we expect it to work better on trending markets. Additionally, the indicator answers the questions: what is the current market momentum, where are the actions happening and how volatile is the market?

The indicator comprises of three bands, the upper band, the middle band and the lower band. The upper band is the representations of the highest high of the previous periods, the lower band is the representation lowest low of the previous periods, the middle band on the other hand is the representation of the average of both the upper and lower bands.

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[Tradingview.com image]

When the actions are happening within the upper band, it signifies that the asset is rising in value and a trader will hope to trade long. When the. Actions are happening within the lower band, traders will look for sell opportunities.
When the actions occurs within the middle band, it shows low volatility.

Q2
Does it explain in detail how Donchian Channels are calculated (without copying and pasting from the internet)?

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CALCULATION OF DONCHAIN CHANNELS.

To make this calculation it will be necessary to obtain the lines of the channels. This will be relative to the number of periods we are working with.

1•Upper band is the highest high within the past period.
2• Lower band is the Lowest low within the last periods
3• Middle band is the result of upper band - the lower band divided by 2 ( UB - LB ÷2)

☑️☑️

Periods can be configured according to a traders choice, however, 20 periods are often used as the standard configuration. The periods are the number of candles based on the timeframe a trader chooses.

Example:

Suppose we are working with 15 minutes timeframe, and we have chosen 20 periods as the configuration of our indicator, it means that each candlestick will represent 15mins and the period is 20 number of previous candlesticks. The upper band will be the highest high within this previous 20 candlesticks. The lower band will be the lowest low within the previous 20 candlesticks. The middle band is the average of the the upper and lower bands.

Q3
Explain the different types of uses and interpretations of Donchian Channels (With examples of bullish and bearish trades)?

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USES OF DONCHAIN CHANNELS

The indicator has varying uses and many ways to read it's signals.

1• IDENTIFYING TREND.

An uptrend is established when the candlestick movement crosses the middle line going up.
A downtrend is seen in the opposite of the uptrend when the candle chart crosses the middle line going downward towards the lower band.

If the chart rallies round the middle line, it shows indicision and the market is not trending.

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TRADING REVERSALS USING THE DONCHAIN INDICATOR.

Reversal refers to a trader waiting for turning points in the market to enter a position. Donchain indicator signals are triggered when the price chart crosses the middle line of the indicator to either side.

Bullish reversal signals.

When the chart moves from below the central line and to above it it shows a possible bullish rally and a possible entry point for buy trade.

For bullish reversal signal, when the price chart crosses the middle band, a trader could hope to enter a long position and will target exit at the upper Bollinger. Stop loss should be placed below the middle band and a take profit before the upper band. As beginners, we should use 1:1 risk to reward ratio. The little our profit target is, the little our risk.

When the price chart touches the upper line of the Bollinger, it means a breakout and a traders decision could be to remain in the trade as a possible trend continuation is indicated. In the event a breakout fails to occur, exiting the trade becomes an option because the price will likely reverse to the opposite direction.

Bullish signal is equally indicated when the price chart did not touch the lower band before reversal. When no breakout occurs, no trend continuation is indicated and therefore we can take buytrade setting our stop loss at the lower band line. Take profit could target the upper band, however, using trailing stop loss is important here, markets are most times unpredictable. Using trailing stop loss will minimize loosing already gained profit from our position.

See image below.

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Bearish Reversal Signals
  • Bearish reversal signal is indicated when a bullish breakout did not occur. When the price chart fails to touch the upper line, a reversal is possible. A trader can hope to trade sell, setting stop loss at the upper band and targeting take profit at the lower band.

As for me, to minimize loss, I prefer not to be greedy. I always set the take profit before the target area.

A stronger signal is sent when the price chart crosses the middle band toward the lower band. In this case, stop loss is placed at the middle band and take profit is placed before the lower band.

Using Donchain indicator while trading bullish reversal uses same method but acts in opposite direction depending on the movement.

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Now let's take a look at a second trading strategy - trading breakouts.

TRADING BREAKOUTS.

Donchain indicator identifies breakout when the candle chart touch either the upper or lower bands.

BULLISH BREAKOUT

A bullish breakout occurs when the candlestick chart touches the upper band of the indicator. Remember that the upper band represents the highest high within the working period. Therefore, when the price chart touches the upper band, it indicates a new higher high and a breakout from the previous higher high. In that case, a trader will be looking for opportunity to enter short position for buy. Stop loss should be placed below the previous candle. Using 1:1 risk to reward ratio is advisable for beginners.

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Another pattern is the ride pattern. Just as the image above indicates, the price chart has crawled to the bullish side. Reversal and retracement happens between the middle band and the upper band . In this case, we can see great opportunity to open a trade when the price falls towards the middle band and the upper band becomes our take profit target.

BEARISH BREAKOUT

A bearish breakout occurs when the candlestick chart touches the lower band, a trader will be looking for opportunity to trade sell. Stop loss should be placed above the previous candle and take profit should be determined using the risk to reward ratio ( 1:1 preferred for beginners)

Note that trading breakouts, it is advisable to use trailing stop loss. This will prevent us from loosing the profit we have already made.

DIFFERENCE BETWEEN DONCHAIN AND BOLLINGER BAND.

The differences that are observable are that at Bollinger bands the lower and upper bands stands as the reversal areas. Once the price chart touch or cross these areas, a possible reversal could be imminent. Reversal equally occur at the middle band though depending on the dominant trend.

Donchain bands breakout means a possible continuation in the trend, rather than a reversal.
Stronger Signals are obtained at the middle bands of the Donchain unlike the Bollinger bands .

Although this two indicators may seem similar in appearance, they are completely different indicators.

PRACTICE SECTION

"Make 1 inning using the "Donchian Channel Breakout Strategy" and make 1 inning using the "Reversal and Retracement Strategy" . You must explain the step by step of how you analyzed to take your entry and make them into a demo account so I can evaluate how the operation was taken."

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TRADING USING REVERSAL STRATEGY.

With the above understanding, I will enter a position for reversal trade. This sample demonstrates an example from the two methods to trade reversal using Donchain channels.

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In the above image of XRPUSDT, We can observe a downward trend as shown by the red candles. At point marked A the second candle opened above the previous showing a retracement.

At point marked B I entered the trade when
1• The green candles has appeared.
2• when the candles has crossed the middle band from bottom to up.
3• The position was taken a candle after the cross.

At the point labelled C shows my take profit and stop loss setting. I used 1:1 risk/reward ratio.

TRADING USING BREAKOUT STRATEGY.

I entered the below trade when a breakout occured in the upper band. I prefer allowing two candles before my entry. This is done to ensure that the movement is not weak and also erase false signals.

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The below image explains why it is important to use trailing stop loss. Here I was on profit. I have almost hit the target before the price retraced.

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CONCLUSION.

Donchain channels when understood is an easy indicator to read trend and make entry for buy and sell signals.

The signals can easily be understood by new traders and afford them opportunity to make good entries. There is need to always use trailing stop loss especially when trading breakouts.

Just like every other indicator, Donchain channels are best combined with other indicators like RSI.

use of image
All images for this post is drawn from tradingview.com aside from the cover image. Source

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Please @lenonmc21
the edit I made on this post was just to add image source only. You can equally crosscheck it

Please, prof, @lenonmc21
check my work

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