Donchian Channel Definition:
In the Donchian Channel the channel bands are determined by the highest high and the lowest low during the bar period; default is 20 bars. This means that the top channel band is always drawn based on the highest price during the last 20 periods, and the bottom channel band is drawn based on the lowest price in the same amount of time. The middle line is exactly that -- the mid-point between the top and bottom channel.
Donchian Channels are used in various ways. Common uses include: 1) breakout/breakdown indications, 2) reversals indications and 3) trend confirmation. For breakouts the channel bands serve as support and resistance areas and traders often set entry orders (long/short) as price breaks the bands. For reversal plays some traders enter when the price merely touches the bands and the direction of the price pivots. As a trend confirmation indicator traders will use the mid-line as confirmation to remain in a trade long or short depending whether price is above or below the center line. If above be long and below be short. If the price crosses the midline, a change in trend is possible, and a counter-trend trade can be triggered in the reverse direction. The Donchian Channel was introduced by Richard Donchian.
The Donchian Channel entry and exit signals are typically the most meaningful when the price and volume of the chart being analyzed have also set up a bullish or bearish pattern. Using the Donchian Channel for additional confirmation of what has already been "read" in the chart can be a powerful addition to the assessment tools used by a technical analyst.