The Donchian channel is a technical indicator that is made up of three lines, as shown in the chart below. The upper channels track the highest price attained during a specific timeframe, such as 20 periods, while the lower channel tracks the lowest price hit in the previous 20 periods. The middle channel is the average of the values of the upper and lower channels over the chosen duration.
Unlike many other indicators, the Donchian channel does not include the prices of the current candle (period). It is made up of previous values only, making it a lagging indicator.
Chart 1: CAD/JPY 1-hour chart with Donchian channels
How to use Donchian channels in trading
1. To determine trend direction
You can use the Donchian channel in several ways to improve your trading. One of the most common uses of the Donchian channel is to determine the direction of an existing trend using the middle band.
Basically, the price of an asset is said to be in an uptrend when it is trading above the middle channel, while it is considered to be in a downtrend when the price is below the middle Donchian channel.
Therefore, you should only take bullish trades whenever the price is above the middle band and you should only consider short trades when an asset’s price is trading below the middle Donchian channel.
2. Pinpoint potential trade entries
Another way to use Donchian channels is for identifying potential trade entries. You can do this by taking long trades when the price touches or breaks above the upper channel. The opposite is true of taking short trades, which you should seriously consider whenever an asset’s price touches or breaks the lower Donchian channel.
The logic behind these trades is that price typically touches the upper band when it has reached a new 20-day high, which is usually an indicator of the existence of a strong uptrend. The same is true of instances where the price touches or breaks the lower channels, which represents a new 20-day low and could be the trigger for a sustained downtrend.
3. Use it to profit from sustained bullish/bearish trends
Another brilliant way to apply the Donchian channels to your trading is by using them to profit from extended bullish or bearish trends once you have identified a 20-day high or low using the other methods. The key to this is to use the middle channel as a trailing stop loss order, which will keep you in such a trend for a long time.
Remember that we consider the middle band as a defining level below which the price is in a downtrend and above which the price enters an uptrend.
This means that if you are in a short trade and are profiting from a sustained downtrend, you can close your trades once the price crosses above the middle band, which would indicate the end of the downtrend.
The opposite is true when you are riding an extended uptrend with a long trade that you took based on the conditions discussed above. You can close your bullish trade once the price drops below the middle band, which would signal that the bullish trend is over.
Deconstructed Donchian channel chart
This is a demonstration of how to use the Donchian channel in your trading
Chart 2: Using the Donchian channel in your trading
Point A: A strong downtrend got underway after the price hit the lower Donchian channel. This provided an excellent entry for a short trade.
Point B: The downtrend ended at this point after the price crossed above the middle band. You should have closed the short trade at this point.
Point C: This was a false bullish trade signal as the price headed lower.
Point D and E: These are points where the trend changed direction.
Beware of false signals
As with other indicators, you should be wary of false signals. Keep in mind that the price does not always continue rising once it has hit the upper channel, just like it does not always keep falling once it hits the lower band.
Therefore, you should use your own discretion when trading using the Donchian channel indicator, or incorporate other indicators within your analysis to identify and avoid false signals.
The bottom line
There is no perfect indicator or trading system because the financial markets are quite unpredictable, so you will have losing trades from time to time.
The average true range (ATR) indicator is a very versatile tool that can be used by all types of traders to improve their trading results. Some of the ways a trader can use the ATR indicator include as a key component in setting stop loss orders, as a trailing stop, to determine potential trade targets, and to validate or invalidate potential trade setups.
How the ATR can help you set your stop loss order
Most traders use the ATR indicator to set their stop loss order, determining the ATR value at their trade entry point and using it as their stop loss distance.
Always remember that your stop loss distance should be aligned with your trading strategy and time frame. Day traders typically use tighter stop losses because they are usually in and out of their trade positions within short periods of time.
On the other hand, swing traders, trend traders, and position traders usually hold their positions for much longer periods, which means they need wider stop loss orders to account for market fluctuations over longer periods of time.
Therefore, many day traders may find that they can use the value of one ATR as their stop loss distance, while swing and trend traders may multiply the ATR value by 2 or more to attain an appropriate stop loss distance.
Figure 1: How the ATR typically behaves throughout the trading day
How to use the ATR for trade entries
The ATR can also be used to time your trade entries with the main goal of getting better entries and avoiding trades that are likely to result in losses. The ATR indicator measures the distance that a particular asset moves over a given time period, so traders can use the indicator to gauge the validity of a trade signal.
For example, a stock may trade within a $50 range each day, according to the ATR values on the daily chart. This can be very useful to a trader who is looking to trade the stock.
If a day trader gets a buy signal during trading hours yet the stock has already booked a $40 gain, he may choose to ignore the trade given the small profit potential on the intra-day trade.
However, a swing trader may take the same trade if he has a larger target and can hold the stock for several days to achieve that target.
Figure 2: The ATR applied to the S&P 500
Using the ATR for trade targets
A day trader can use the ATR to determine their price targets because the ATR tracks the value of an asset’s movement over a specific time period. For example, a stock may move by $0.3 per minute, which means that if a day trader wants to capture a $1.5 gain on the stock, they know that they might have to wait at least 5 minutes for their trade to work out.
The same applies to forex trades, where the ATR tracks the average movements of a currency pair and can help you figure out how many pips you can target within a specific time frame.
For example, if the GBP/USD currency pair moves by 30 to 40 pips each day, a swing trader with a 150-pip trade target may have to hold their trade for five trading days to hit their target.
Using the ATR as a trailing stop
You can use the ATR as a trailing stop loss order in much the same way that you can use it to determine where to place your stop as described earlier in this article. The main difference between a trailing stop loss order and a normal stop loss order is that a trailing stop loss order usually moves as the price changes.
The trailing stop loss is set at a specific distance similar to a normal stop loss, but it moves higher or lower as the price changes depending on whether it’s a bullish or bearish trade in order to lock in some of the profits.
This is an excellent feature because sometimes a trade may go in your direction for a long period of time and post significant profits only to reverse later and close at a loss. The trailing stop loss locks in your gains and ensures that a winning trade does not turn into a losing one.
You should never use the ATR indicator as the only tool in your trading arsenal. Instead, it’s best to combine it with other indicators, such as the moving averages, as part of your trading plan.
The interbank market is a decentralised, over-the-counter marketplace where banks and financial institutions engage in forex trading with one another. It is a wholesale market where currency trading is channelled through various market participants either directly or through electronic platforms. While interbank trading is generally proprietary in nature, with banks employing these transactions in their own accounts and at their own risk, it is possible that a few transactions are carried out on behalf of their clients.
Interbank markets can be broadly segregated into the following three groups:
The spot market, or cash market, is an over-the-counter marketplace where currencies are traded for immediate delivery. The standard settlement in the spot market is T+2 working days, with the exception of the Canadian dollar, the Turkish lira, the Philippine peso and the Russian ruble, where the settlement is completed on T+1 working day.
The forward market is another over-the-counter marketplace where customised forward/future contracts are traded, with the settlement taking place on the expiry or the future maturity date of the contract.
The Society for Worldwide Interbank Financial Telecommunications (SWIFT) is a secure network used by financial institutions to send and receive information related to financial transactions. The network connects thousands of financial institutions in hundreds of countries, where tens of millions of messages are exchanged on a day-to-day basis. Although SWIFT is not directly made up of financial transactions, it facilitates payments among institutions associated with it.
Here is a look at the abbreviations for some of the major global currencies:
Source: BIS Triennial Central Bank Survey 2016
Key players in the interbank market
The key participants in the interbank market include central banks, commercial banks, investment banks, hedge funds and large corporations. The goal of all the participants besides the central bank is to profit from forex transactions for which they have dedicated dealers and dealing desks to facilitate the speedy flow of information and support their forex trading operations.
The role of the central banks is to provide liquidity through money market operations, protect the foreign exchange rate from spiralling out of control, and maintain sufficient forex reserves. Some central banks also intervene in the forex markets from time to time to support the home currency during periods of high volatility.
According to the Bank for International Settlements’ (BIS) Triennial Central Bank Survey in 2016, the average daily turnover in the global forex markets stood at $5.1 trillion in April 2016, which is slightly below the $5.4 trillion that was noted in April 2013. Among the total turnover in the foreign exchange markets, FX swaps were the largest traded instruments, accounting for 47% of the total turnover in April 2016; spot FX, meanwhile, contributed 33%.
Among market participants, reporting dealers accounted for 42% of the total turnover in the forex markets in April 2016, compared to 39% in April 2013. The turnover by non-reporting dealers at banks came in at 22%, with institutional investors contributing around 16% of the total turnover during the corresponding period.
Top traded currencies in terms of turnover
The BIS Triennial Central Bank Survey of 2016 showed that the US dollar continued to remain at the forefront as the world’s most dominant currency, contributing to about 88% of all trades in April 2016. The market share of the euro was at a distant 31%, while the Japanese yen garnered 22% of the aggregate market share during the corresponding period. The Australian dollar and the Swiss franc were the other heavily traded currencies, with a market share of 6.9% and 4.8% respectively.
In the emerging markets, the Chinese renminbi jumped to #8 among the most actively traded currencies, with the daily average turnover jumping from $120 billion to $202 billion between April 2013 and April 2016. In addition, the market share of the renminbi surged from 2% to 4% for the corresponding period. The rankings of other emerging market currencies, such as the South Korean won, the Indian rupee and the Thai Baht, also advanced by a few places. In contrast, the turnover in the Mexican peso and the Russian ruble declined significantly.
Here is a look at the top traded currencies and currency pairs: