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Technical Analysis, Studies, Indicators:

Donchian Channel Width (DCW)


Donchian Channel Width is measuring the distance between Upper and Lower Bands of the Donchian Channel. It is used in technical analysis to measure a security's volatility.

Description

The Donchian Channel was developed by Richard Donchian and it could be compared to the Bollinger Bands. When it comes to volatility analysis, the Donchian Channel Width was created in the same way as the Bollinger Bandwidth technical indicator was.

Technical Analysis, Signals and Trading Systems

As was mentioned above the Donchian Channel Width is used in technical analysis to measure volatility. Volatility is one of the most important parameters in technical analysis. A price trend is not just about a price change. It is also about volume traded during this price change and volatility of a this price change. When a technical analyst focuses his/her attention solely on price analysis by ignoring volume and volatility, he/she only sees a part of a complete picture only. This could lead to a situation when a trader may miss something and lose money. Lets take a look at a simple example how volatility may help a trader:

  1. Most of the price based technical indicators are lagging indicators.
  2. When price moves on low volatility, it takes time for a price trend to change its direction and it could be ok to have some lag in an indicator.
  3. When price moves on high volatility, a price trend changes its direction faster and stronger. An indicator's lag acceptable under low volatility could be financially suicidal now - Buy/Sell signals could be generated when it is already too late.

Another use of volatility - very popular one - it is to adapt a stop loss strategy to it:

  • Smaller stop-loss recommended in low volatility periods. If it is not done, a stop-loss could be generated when it is too late.
  • Bigger stop-loss recommended in high volatility periods. If it is not done, a stop-loss could be triggered too often and you may miss good trades.

As you may see on the simple examples above, by embedding the volatility indicators into a trading system could be beneficial to this trading system.

Donchian Channel Width is very simple in analysis. When Donchian Channel Width moves to its high levels it is an indication of high volatility. When it moves down it signals low volatility. A simple example of using the Donchian Channel Width in a stop-loss strategy would be setting a stop-loss n-times of Donchian Channel Width. If a trader makes a decision to use stop-loss which is equivalent to 3-time of Donchian Channel Width value then

  • When Donchian Channel = 1 point, a stop loss would be set 3 points from an entry price.
  • When Donchian Channel = 3 points, a stop loss would be set 9 points from an entry price.

Chart 1: SPY stock chart with +DX and -DX indictors and DX index.

Donchian Channel Width Stock Chart

Donchian Channel Width Formula and Calculations

Donchian Channel Width is a technical indicator derived from the Donchian Channel overlay and it is calculated as the difference between Upper and Lower Bands of the Donchian Channel.

 1. Calculate Donchian channel bands:

Upper line = High over selected period
Lower line = Low over selected period


2. Calculate Donchian Channel Width

DCW = (Upper line- Lower line)


By for MarketVolume.com

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