Donchian Breakout Forex Trading Strategy

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Donchian Breakout Forex Trading Strategy

Price usually moves within a range which is acceptable to the market. Bulls and bears would usually trade within a range that they deem as equitable. Most transactions would take place within ranges. This is it is said that the market would trend for only 20% of the time and range at about 80% of the time. If you would look at a price chart and zoom it out, you would easily see how price moves within these ranges. What you would often see is price moving up and down within a given range.

However, there are instances when price would break out of a range. These breakout conditions are early indications that price is about to make a strong move in one direction. This is because outside of these ranges, the market would already deem price to be unfair. This would cause price to move strongly in one direction as market bias would start to shift heavily to one side.

Range breakout trading is a great trading strategy. However, the market would not usually move within the confines of a fixed range. Donchian Breakout Forex Trading Strategy allows traders to systematically trade breakouts from a dynamic range. It makes use of two indicators. One to identify the dynamic range, and the other to confirm the momentum shift.

Donchian Channel

Donchian Channel is a technical indicator developed to help traders identify the most recent range of the market. It basically identifies the highest high and the lowest low of the past n periods.

The Donchian Channel indicator simply plots three lines. The top most line is based on the highest high of a given period, while the bottom line is based on the lowest low of the same period. The middle line is simply the median between the two lines. This forms a channel like structure which marks the range of the market and its median within a given period.

The Donchian Channel could be used much like other band or channel types of indicator. It is mainly used to identify momentum and trend bias.

Trends could be identified based on where price action is usually moving in relation to the middle line. The middle line would also usually be moving in the direction of the trend as price action creates higher or lower swings.

It could also be used to identify momentum. Traders could simply interpret price closing outside of the channel as a momentum indication. This is because price is actually breaking the high or low of a given range.

Lastly, it could also be used to identify volatility. A Donchian Channel that is contracted means that price is staying within a tight range, while a Donchian Channel that is expanding means that price is gaining volatility, breaking the highs or the lows or both.

DeMarker Indicator

The DeMarker (DeM) indicator is a technical indicator that is used to identify trend and momentum. It basically compares the most recent high and low of price within a given period with the prior period. This creates an indication of the demand or supply of a particular trading instrument.

The DeMarker indicator is plotted as an oscillator. It basically plots a line that oscillates within the range of 0 to 1. It has markers on 0.3 and 0.7. This represents the normal range of the DeM line. A DeM line that breaks above 0.7 could indicate an overbought market, while a DeM line that drops below 0.3 could indicate an oversold market.

It also has markers at 0.5, which represents the midline of the range. A DeM line that is generally above 0.5 indicates a bullish trend bias, while a DeM line that is generally below 0.5 indicates a bearish trend bias. A DeM line that is crossing over 0.5 could also be interpreted as a possible trend reversal.

Trading Strategy

This trading strategy is a momentum breakout strategy that uses the range of the Donchian Channel to anticipate possible momentum breakouts.

To trade this strategy, traders should identify a market that ranging by looking for markets with flat or ranging Donchian Channels. Traders should then wait for a momentum candle to break outside of the Donchian Channel.

The DeM indicator is used to confirm the momentum shift. This is based on the DeM line crossing over its midline.

Indicators:

  • Donchian Bands
  • DeMarker

Preferred Time Frame: 15-minute, 30-minute, 1-hour and 4-hour charts

Currency Pairs: FX majors, minors and crosses

Trading Sessions: Tokyo, London and New York sessions

Buy Trade Setup

Entry

  • The Donchian Channel should be ranging.
  • A bullish momentum candle should close above the upper line of the Donchian Channel.
  • The DeM line should cross above 0.5.
  • Enter a buy order as soon as the conditions above are confirmed.

Stop Loss

  • Set the stop loss at the low of the last two candles.

Exit

  • Close the trade as soon as price closes below the midline of the Donchian Channel.

Donchian Breakout Forex Trading Strategy

Donchian Breakout Forex Trading Strategy 2

Sell Trade Setup

Entry

  • The Donchian Channel should be ranging.
  • A bearish momentum candle should close below the lower line of the Donchian Channel.
  • The DeM line should cross below 0.5.
  • Enter a sell order as soon as the conditions above are confirmed.

Stop Loss

  • Set the stop loss at the high of the last two candles.

Exit

  • Close the trade as soon as price closes above the midline of the Donchian Channel.

Donchian Breakout Forex Trading Strategy 3

Donchian Breakout Forex Trading Strategy 4

Conclusion

This trading strategy is a great momentum breakout strategy. It allows traders to systematically trade breakouts based on the high or low of a range.

Price closing outside of the Donchian Channel confirms that price has broken the and closed beyond a given range.

The key to trading this strategy well is in identifying the right ranging markets and the right momentum candles. These candles should be significant in relation to the range of the Donchian Channel.

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