Donchian Price Channels

As I discovered the technical analysis of the financial markets for the first time, I read a book about a position trading strategy with the Donchian price channels. The price channel was developed by the famous commodity trader Richard Donchian. It simply indicates the highest and lowest points of n periods of the price.

This strategy used two periods a 55-day and 20-day price channel. The 55-day channel was used to enter positions and 20 for exiting them. In addition to that the strategy has a few enhancements: Exiting positions if the Average Directional Index of a 14 period shows a peak over 70 points. Positions are also closed if after breakout the price does not close over the breakout level within five days. This strategy was developed a few decades ago, so I was interested if the strategy was still valid, so I did a strategy test on the EURO/DOLLAR with Excel.  

The first thing I noticed, when I entered the trades into Excel, was that this strategy carries an enormous amount of risk. Already in the first trades there is a loss of 1000 Euros, which is a 20% draw down! As the cumulative amount of money compounds, the losses and profits get bigger. If there would have been five losing trades in the beginning, the virtual account would have been gone.

The worst losing trade happened on the 27.07.2010 with – 8140,15 € and the best trade was opened just before the worst trade on the 22.4.2010 with a profit of 15 737,78 €. As the capital accumulates, the profits and losses get more volatile. 

So in conclusion to this strategy testing, I could say this could be a good strategy for those who are looking for a position trading strategy in forex. Later on I will run the same test on commodities and some equity indexes. With a 5000 Euro start capital the return over a 10 year period is high but also the risk. We don´t know if this strategy worked only in the past but not in the future. Markets are changing. The rapid change in the variance of the returns can be a result of the markets becoming more structured with automated trading.