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.
