Donchian Channels are a technical indicator that helps to identify meaningful levels of support and resistance in the markets. First developed by Richard Donchian – a successful trend-following trader and proponent of trend following strategies – Donchian Channels help traders to recognize potential buying and selling opportunities. They seek to identify bullish and bearish extremes that favor reversals as well as higher and lower breakouts, breakdowns, and emerging trends.

Donchian Channels are composed of three lines. The upper and lower bands represent highs and lows over a chosen time frame. This time frame is usually set at 20 periods, in which case the lines will indicate the respective highs and lows of the past 20 periods. The middle band simply computes the average between the highest high over N periods and the lowest low over N periods. These points identify the median or mean reversion price.

A currency pair’s movement between the upper and lower bands is used to identify trade signals. For example, if the price movements stay between the two bands and the middle band remains flat or moves sideways, this generally signals a period of consolidation, which is often a precursor to a break in trend. Alternatively, if prices break any one of the two bands, this could signal a reversal or a potential continuation of the current trend. In either case, the Donchian Channels provide visual clues of when to enter or exit a position.

The Donchian Channels also provide a reliable way to identify potential trend reversals. This is done by comparing the heights of the two bands. If the upper band is relatively higher than the lower band, this indicates the presence of an upward trend and the possibility of a favorable buy position. On the other hand, if the lower band is relatively lower than the upper band, this signals a downward trend and the possibility of a favorable sell position.

Overall, Donchian Channels provide a powerful, visual tool to gauge market behavior. When used alongside other technical analysis tools, they can help traders identify potential support and resistance levels, as well as possible trend changes. As with all indicators, however, it is important to use Donchian Channels within the broader context of your own particular trading strategy.