How to Use the Donchian channel and Volume Oscillator to Trade

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This is what you don’t know about online trading:

Any market move, either up or down, not backed by enough trading volume can be brushed as invalid.

Let’s look at a case scenario:

Assume there is an uptrend and bulls are leading the party. Prices go up but buyers aren’t enough to keep the prices rising. What will happen?

You guessed right. The trend will reverse.

Why is this scenario important?

It is important because it makes the basis of this post.

If you look around, you will notice a ton of strategies leveraging the Donchian channel indicator to generate buy and sell signals. But what is the benefit of a signal if it comes to a ranging market?

This article adds to our list of strategies – but, instead of the normal signals and trend confirmation routine, we will go a little in-depth to discuss other things you didn’t know about volume trading.

Because hey, what’s the need of being so excited about market movements if they don’t have enough traders to push prices further in the direction of your prediction?

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Understanding the Donchian channel.

History remembers the Donchian Channel as the trading tool that helped a great deal in turning a group of newbie traders in Wall street into millionaire traders in just two weeks.

The most successful trader on the strategy in use; the turtle strategy (that comprises the Donchian channel and the Average true range oscillator) easily turned a $1M trading account into $30 Million profits in months.

It is thus very important to not only consider the Donchian channel legendary but important in every genius trader’s life.

But what is this Donchian Channel, what is it made of and how does it work?

The Donchian Channel is a trend analysis tool and it is made up of three trend lines which when put together, form the channel we are talking about.

The first trend line is the upper band. This line represents the highest high asset price for a specific ‘n’ period. What happens is that, when the price action occurs above the middle band towards the upper band, it denotes a looming uptrend.

The second trend line is the lower band. This is plotted by computing the lowest low price for the same ‘n’ period. Again, when the price breaks and closes below this band, a downtrend is imminent.

Additionally, there is the third line, the middle band. It represents the average between the upper and the lower band.

i.e [Upper band – Lower band] / 2

As you can already tell, the presence of a top and bottom band gives out the channel in between. This is where 90% of price action occurs.

How about the 10%?

That would be breakouts.

You see, the bands act as invisible dynamic support and resistance levels. As such, when prices break the bands, it means something is going to happen.

Also, most traders use the 20-period as the default parameters for the Donchian channel.

But it doesn’t mean you should too. This is something you can adjust to your liking and based on your trading style.

Donchian channel trading signals.

To generate trading signals with the Donchian channel, you need to observe the two bands and how they interact with prices.

Without a doubt, you will notice that the Donchian channel also checks volatility.

  • When the Donchian channel is wider (bands are further away from each other), it indicates high volatility.
  • On the flip side, a narrow channel means that the volatility is limited. Here, the bands are closer together.

Volatility

How to determine when to buy and sell signals when using the Donchian channel on Olymp Trade:

Donchian Buy signals.

  • When prices cross the average band upwards, that’s a bullish trend. Consider buying.
  • If you see the price movement is taking place above the middle band and the channel is moving up. This gives an uptrend signal.
  • Use candlestick breakout as a signal to enter a trade.

Up trend - Donchian Channel

Donchian channel sell signal

  • Open a sell position when the price breaks close below the lower band, giving you the bearish breakout signal
  • When you see candles forming below the middle band and the channel is moving down, consider shorting the asset because such set up denotes a downtrend.

Once you receive these signals, don’t rush to open a trading position, lest it’s false and you lose. Confirm that the direction is indeed downtrend or uptrend before trading.

Because let’s face it. No indicator is 100% true. As such, you need another indicator to confirm the signals.

For this reason, we’ll add the volume oscillator to help us with the signal confirmation.

Understanding the volume oscillator.

A volume oscillator is a technical analysis tool used to validate the price action of the underlying asset.

As such, it’s easy to instantly look at and decide whether to buy or sell.

There is one thing you need to consider to make sound trading decisions through:

Any time you are using volume oscillator, look at the price and the volume momentum whether they match or not.

You will get two answers to consider trading:

Prices and volume momentum are in line. If so, the prevailing trend will probably continue.

On the flip side, if the two don’t agree, a trend reversal is bound to follow.

To measure the relationship between volume and price, the volume oscillator leverages two moving averages; a fast MA and a slow-moving average.

Now, the volume oscillator gets the difference between the fast moving average and slow-moving average and presents the results as a positive and negative oscillation on the zero line.

When the fast-moving average is higher than the slow one, the volume oscillator keeps above zero, showing a tendency to increase in volume.

If the oscillator is below zero, it means that the slow-moving average is higher than the first one and this shows a tendency of decrease in volume.

Interpreting the volume oscillator signals.

With an understanding of negative and positive values, you can infer that:

During a rallying market, the volume oscillator should be rising. As the underlying asset attains the overbought status, the oscillator should reverse its direction.

Using volume oscillator to confirm Donchian channel signals.

Since we have already covered how the Donchian channel generates signals, I will jump right into how to use the volume oscillator to confirm the same.

Confirming the buy signals.

When the prices break the upper band in the Donchian channel and close above it, do not open a buy position yet. Look at the volume oscillator, the value should be above the zero line (spike) indicating that there is an increase in volume.

Confirming buy signals

 

Additionally, an uptrend should be followed by an increase in trading volume. This shows you that the trend is strong and will continue.

Confirming sell signals

A sell signal is received when the price breaks and closes below the lower band, giving you a breakout of support. Or when the asset is trading below the middle band.

For this to be a strong move, it should be accompanied by a spike in trading volume.

Follow these simple confirmation strategies and filter out false signals.

Trading volume Volume

Wrapping up

If a bullish or bearish signal is accompanied by a spike in volume, it tells you that it is a strong trend. And therefore, you should open a position.

On the other hand, if the price movement is accompanied by low trading volume, it indicates that the move is weak and isn’t going anywhere and will probably reverse.


*Risk warning:

The information provided does not constitute a recommendation to carry out transactions. When using this information, you are solely responsible for your decisions and assume all risks associated with the financial result of such transactions.
 

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