The Price Channel or Donchian's Four Week Rule is a simple and effective trend following, channel breakout system.
Channel breakout systems were shown by research to be one of the top trading systems to generate significant profits
Louis Lukac's research from 1975 to 1986 compared 23 trading systems. Moving averages and channel breaklouts came out as the top performers and Lukac suggested a channel breakout as the best starting point for technical trading. (Lukac, Louis; The Financial Review, November 1990).
The Price Channel is a simple breakout system. As with all trend following systems, the Price Channel works well in up trends or down trends, but doesn't work well in a sideways channel. The signals derived from the Price Channel are based on the following basic rules:
As a trend following system the Price Channel indicator is not meant to catch tops or bottoms. Trend traders may want to extend the period to eight weeks to wait for significant trend signals. Similarly, some traders shorten the time period to a more sensitive 1 or 2 weeks for liquidation purposes.
The following signals are offered by the Price Channel indicator:
These signals should, of course, be combined with the use of other indicators to provide confirmation. For example, a relatively simple, yet effective, approach to exiting a trade based on a price channel would be to watch for a break in the long-term trend.
Some Ideas for Applying Shorter Time Periods:
Also see Keltner Channels and Bollinger Bands.