Donchian's Four Week Rule/Price Channel

A technical charting interpretation of the Donchian's Four Week Rule/Price Channel

The Four-week Rule is a basic method that may not seem glamorous in the company of Fibonacci Numbers and Japanese Candlesticks - but it is a profitable method that is still used today.

Despite its obvious shortcomings, as a trend-following system, - it works well in up or down trends, but not sideways trends - the Four-week Rule is a tool that should be in every technical analyst's repertoire. It was developed by Richard Donchian in the early 1970s for commodities and futures, and has been successfully applied to stock analysis.

The

question is: How can you make it work for you?

Also known as the "Price Channel" or "Donchian Channels," the Four-week Rule may be a basic tool. But in the right hands, it can be powerful. In other words, the rules may be simple, but applying them is not. It works to the extent of the analyst's abilities.

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The

rules according to Donchian

The Four-week Rule is a method that includes a set of charting rules that are generated from the price channel as well as a set of trading rules. The mistake that some analysts make is to use the price channels without the trading rules. It is the combination of both sets of rules that make the method effective.

The

charting rules

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Donchian's Four Week Rule/Price Channel

The

price channel generates the following signals

when applied to stock charts: the upper band of the price the lower band of the price

- buy signals channel; and, - sell signals channel.

are produced when the price closes above are generated when the price closes below

The

trading rules

1. When the price is at its highest in a four week period, buy long and cover short positions. 2. When the price falls below the lows of a four week period, sell short and liquidate long positions. 3. This last rule only applies to future traders, which is "to roll forward, if necessary, into the next contract on the last day of the month prior to expiration.

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Donchian's Four Week Rule/Price Channel

Asthe attempting of you price can to channel. see predict from them. FigureThe 2, trend-following trend breaks before systems the price react to closes movements below the rather lower than band

create When channel interpreting quite has a closed few the signals above price during the channel upper on course band charts, as of shown the buy up in signals trend. Figure are 3. generated The price when channel the price tends to For those where closes breakout, the above who price the use closes upper technical number higher band. stock than When of the false screeners, the we signals day include before use is a reduced three-day a for screen three as can days, with rising a be as rising close seen well close as as in well Figure a price condition as a 4 that price below.

The stock used in all of the chart illustrations, was found using the following stock screen: -what that the price-channel close for the buy, last where three days the price was penetrates higher than the the upper day before band, it. as well as the condition (The best pattern reverse to does wait not for.) apply during sell conditions, three consecutive days down is not the Complimenting the Four-week Rule So miss ensure false opportunities signals? that can you you aren't do due to going increase to the to lagging lose the money effectiveness indicators? in afirst volatile And of equally the or sideways-trending Four-week as important, Rule so how that market can you you due don't to One methods way to to generate add certainty additional to the signals Four-week that Rule provide is a to warning use complimentary or confirmation. indicators or For Averages create trend. example, Note: combined Method, The you rules signals can also use in developed these that another help two you by trend-following systems Donchian, determine do not in if the conflict conjunction system, price with the has Fivewith one really another. the and generated Four-week 20-day Moving a Rule, strong Fiveand 20-day Moving Averages Method rules. analyze These Fivestocks. and rules 20-day where Moving initially Averages intended Method for currency includes markets several but general can also and be supplemental used to The method consists of the following rules: exceeding closing when by A: the one closing full unit was the on maximum the same penetration side of the in moving the same average. direction by an of amount any previous Basic beyond Rule the B: previous Act on 25 all closes closes. that cross the 20-day moving average and close one full unit signal, beyond reverse C: the Within on previous any the close first 15 closes. that 20 days crosses after the day of a crossing that leads closes to one a trading full reinstating position D: Sensitive in the five-day direction moving of the average 20-day moving rules for average closing are: out positions and for 1. Close out long unit moving days. closeout average signals maximum sessions. more positions Should unless average, in signal range either than the the be and both the or direction range penetration greater the above greater above maximum between the when than within of and either 5-day of below the the point 60 the prior the moving currency previous 5-day closing of previous the 15 any moving 5-day average days price closes sessions, penetration than moving in penetration average below for the the do short opposite average range within not exceeds the on act positions, from 5-day the direction the during on preceding by same moving Rule the one the by 20-day side D at to preceding unit average closeout least the 25 of the moving Rule trading one 5 for D day full 25 2. Reinstate positions paragraph high Rule ground. C signals 1 are in the achieved, direction in (b) the of If the direction a new basic Rule of trend the A basic basic are given trend trend by is (a) closing given, when or in the (c) a new condition if new low Rule in or B new and 3. unless be exceeded Penetrations at was twoset consecutive of up. two (Richard units or closes Donchian, do were not on count the December side as points of 1974to penetration be exceeded when by the point to Futures quoted byleast Cornelius Luca in article), as Technical Analysis Applications in less the Global Currency Markets , 1997.

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Donchian's Four Week Rule/Price Channel

When we in Figure can an we see 6. look that at signals the charting are generated signals inearlier Figure on 5 inand generated the 20-day trend by than the the 5- and price 20-day channel method, shown include To better interpret MA cross the system signals such generated as Japanese by the Crosses. 5method, it is advisable to

Combining help intended the trend to confirm to when the price 5information basic channel 20trend-following day about signals moving the are potential average techniques generated. trend cross change. system but toand provide with These the modifications more Four-week information Rule are not can about rules. In summary, getting the Four-week Rule work for you may be as simple as - following the 1. Use itreplace right -and as a method with a set of trading rules charting. 2. Have discipline - its buy and sell strictly according to the trading rules. 3. Compensate for shortcomings -to no system is perfect.

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