BASIC TECHNIQUES
From Turtle Trading To Price Channel Breakouts, Trend-Following Systems Continue To Win
Donchian Breakouts
by David Penn
Buy strength and sell weakness with this simple yet effective breakout trading strategy.
There may be as many different forms of the Donchian breakout as there are moving average crossover or pattern recognition strategies. This is not without good reason. As the authors of The Ultimate Trading Guide note, "Traders are always excited about leading-edge technology, but inevitably fall back on the classical approaches."
Donchian breakout-oriented systems, in which trades are initiated when current prices exceed the high or low price of a given period, are chief among such classical approaches. In fact, elements of the Donchian breakout have found their way into a number of trading systems, ranging from the Turtle trading system to a number of mechanical price-range breakout approaches.
Many who have extended this breakout strategy have cautioned that there is more to trading than n-period breakouts. While this is absolutely true, it need not detract from the effectiveness of Donchian breakouts in terms of entering trades.
One of the more difficult aspects of trading in general and trend-following in particular is establishing when a trend is in place. Occasionally, by the time a trader identifies a trend, a consolidation or short-term reversal (in hindsight, at least) appears to cloud the picture. By waiting for prices to exceed previous highs or lows, according to those who use Donchian strategies, traders are more likely to have probability on their side.
As the Donchian breakout does not provide exit instructions, those who have used such breakouts have had to develop (or borrow) their own exit strategies, often using trailing stops. This discussion, however, will focus on the effectiveness of using Donchian strategy for entering trades.
Figure 1: The SPDRs in a 30-day price channel. Sell signals occur when prices drop below the bottommost price channel line.
...Continued in the February 2002 issue of Technical Analysis of STOCKS & COMMODITIES
Excerpted from an article originally published in the February 2002 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2002, Technical Analysis, Inc.