History

The Donchian Channels (DC) indicator was created by the famous commodities trader Richard Donchian. Donchian would become known as The Father of Trend Following.

Calculation

For this example, a 20 day period is used which is a very commonly used timeframe.

Upper Channel = 20 Day High
Lower Channel = 20 Day Low
Middle Channel = (20 Day High + 20 Day Low)/2

The basics

Donchian Channels are one of the more straightforward indicators to calculate and understand. The indicator simply takes a user defined number of periods (20 Days for example) and calculates the Upper and Lower Bands. The Upper Band is the high price for the period. The Lower Band is the low price for the period. The Middle Line is simply the average of the two.

The main function of Donchian Channels is to measure volatility. When volatility is high, the bands will widen and when volatility is low, the bands become more narrow. When price reaches or breaks through one of the bands, this indicate an overbought or oversold condition. This can essentially result in one of two things. First, the current trend has been confirmed and the breakthrough will cause a significant move in price in the same direction. The second result is that the trend has already been confirmed and the breakthrough indicates a possible small reversal before continuing in the same direction.