The perfect indicator for people who hate drawing levels on their charts

There is no more powerful clue to price behaviour than support and resistance levels. These are the places where prices have turned and stalled in the past, and they litter our charts with clues about where we should watch for reversals and breakouts.

Despite this, many many traders are very reluctant to draw these levels on their charts.

There are a few reasons for this …

• It’s not a one-click job, like
  drawing in an indicator
• It has an element of subjectivity to
  it – one trader may not draw their support & resistance lines in the same
  place as the next trader. This can make the lines feel less trustworthy.
• It can lead to charts looking messy
  and overcrowded with lines that aren’t relevant.
• Support and resistance lines change
  – new ones are emerging all the time, so it’s a task that needs to be redone
  regularly.

As you’ll probably know, I’m a huge fan of drawing these lines in on my chart, but when I found myself looking at a chart like the one below, I had to accept that too many lines can do more harm than good …

So, the indicator I’d like to offer up as an alternative is the Donchian channel.

What does the Donchian channel do?

The Donchian channel is a very simple tool – so simple, in fact that its usefulness can get overlooked.

It consists of three lines: the upper line plots the recent high; the lower line plots the recent low, and the middle line marks the average of the high/low lines.

You specify yourself just how ‘recent’ you want the high/low to be, by inputing the number of candles to look back over.

Here’s an hourly chart showing a 25-period Donchian channel …

Is it a bit of a blunt instrument?

Yes.

But is it better than not including any S&R levels on your chart?

Yes.

And a nice thing about the Donchian channel is that you’ll only have the level showing that’s most recent – rather than multiple levels, some of which are way away from the current price and just not that relevant.

The Donchian levels either side of the current price mark our first ‘areas of interest’ that the price could come across. And the flat areas show points where highs or lows have held for a period of time.

Uses of Donchian channel

• The Donchian upper and lower levels are good places to look for entry signals – either we’re looking for the price to reverse or breakout at these extremes.

• Once we’re in a trade, Donchian upper and lower bands can help with positioning of profit targets and stop levels

• In a strongly trending market, the middle line of the Donchian channel can make a useful trailing stop.

There’s nothing big or clever about the Donchian channel – let’s face it, it’s just a marker of the highest and lowest point in the last X number of candles. But visually, it can be a really useful addition to your charts – especially if you’re reluctant to draw in your support and resistance levels.

On my spread-bet platform, I can easily adjust its colour, so you can make it not too distracting – just a little nudge of where to pay attention for triggering new trades or closing out open ones.

Here it is in the background on a 4-hourly chart. In this case the setting on the Donchian channel is 50 candles …

Of course, a great signal is a crucial part of successful trading, but, just as important is where you find that signal. Knowing the key places where ‘something could happen’ is incredibly powerful when it comes to entering or exiting the market. And this very simple tool can do that work for you.

 

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