Let me ask you something, after identifying a possible trade entry point in Olymp Trade and possibly opening a position, what’s the next thing you do?
Wait for profit?
If you answered “set an exit strategy,” you are right.
Let me explain:
Because when the prevailing trend changes direction (and it will change), all the gains you had accumulated can be lost without a warning.
As such, having an exit strategy before opening a position can be a life saver.
Ready for it? Let’s get down to the basics of this strategy (the Breakout Trading Strategy)
Understanding how the Donchian Channel works.
This is a trend following indicator comprised of three lines derived from moving averages. The three lines build the upper, middle, and lower bands.
Where the upper band represents the highest price of the underlying asset over the “n” period, while the lower band represents the asset’s lowest price over the same period.
Now, the upper band and the lower band encloses a channel. And that’s what we all know as the Donchian Channel.
How about the middle band?
Well, while the upper band shows you the highest price and the lower band shows the lowest price, the middle band, is there to average the two.
In simple terms, the middle band shows the average between the highest and the lowest price of the asset over the “n” period.
Donchian channel signals.
There are in fact more ways Donchian channel can generate trading signals than the once discussed here. But today, we are going to focus on just a few which resonate to this strategy.
Among them is identifying the market volatility.
Ideally, when the bands are moving away from each other (diverging), it is an indication of high volatility.
Conversely, when the bands are closing in together forming a narrow channel then that’s an indication that the market volatility is dropping.
Let’s now learn how to use the Donchian Breakout Trading Strategy.
Trading the Donchian channel breakout.
Most pro traders leverage the Donchian channel indicator to identify and trade breakouts in the market.
This is simple.
Remember the upper and lower bands?
Well, it turns out, the price action often happens inside the channel (just like in Bollinger bands).
But when the price breaks either of the bands, a major trend comes with.
And that is what you will be looking for when using this trading strategy.
As such, I advise against using Donchian channel breakout strategy to trade choppy /ranging markets.
In fact, I suggest you look for a trending currency pair among Olymp Trade’s over 76 traded assets.
Because currencies are very responsive to major news, hugely traded and generally, mostly volatile on Mondays, Wednesdays and Fridays. And volatility is just what we want for this strategy.
So, what does a breakout look like?
Well, whenever you see the price trading higher than the highest price of the asset over the ‘n’ period, I mean the upper band, you should open a long buy position.
On the flip side, when the current price is trading lower than the lowest price of the asset over the ‘n’ period, open a sell position.
Once you have identified the entry positions, you need an exit strategy. Because let’s face it, the party won’t last overnight. Especially when trading currency pair breakouts.
That is where the Parabolic SAR comes in.
Using the Parabolic SAR to Take Profit and to Exit a Loosing Trade.
What is the Parabolic SAR?
The Parabolic SAR is a classic technical analysis tool used to identify instances of a trend reversal. Actually, that is what the SAR means, Stop And Reverse. It tells you when the trend is about to change direction.
The Parabolic SAR uses a series of dots plotted on top or below the price action, depending on the direction of the trend.
As such, during an uptrend, series of dots form below the price action.
Now, when the dots change position and start forming above the price action, it means the trend is about to change direction and head downwards.
The opposite is true during a downtrend, the dots are above the price action. When they change position and move to the bottom, an uptrend is imminent.
Based on this, you can now exit any open position. Either profitably or with a measured loss.
Here is how:
- Buy when the price is trading higher than the upper band on the Donchian channel. Here, the Parabolic SAR dots will be below the price action. Wait for them to change position and move below the price action, then exit the trade.
- Same thing with sell position: open it when the price is trading lower than the lower band. You will see the dots forming above the price action. When the dots change position, you know the drill. Exit the position to enjoy your profits.
And that is the trading strategy derived by combining the Donchian channel and Parabolic SAR.
Final thoughts on Breakout Trading Strategy
There is this rampant trait exhibited by most traders:
Using the Donchian channel to identify overbought and oversold positions. You’d see them opening a short position when the prices touch the upper band. Let that not be you.
Normally, during an uptrend, the prices don’t reverse immediately. Instead, it hugs the upper band for a little longer.
Use the Donchian channel to identify breakouts as we have discussed. Add the Parabolic SAR to show you when to exit the market.
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