Is Using the Donchian Channel With a Breakout Strategy The Best Way of Trading During Volatility?

[Henry Thomason 10]

Instability can be off-putting, but the correct strategy will allow you to take advantage of it.

 

While there are of course countless exceptions, traders generally find that their positions are more profitable during less volatile times of day. There are a number of reasons for this, and it’s something that every trader should work on if it’s an issue. Ideally, you need to be able to trade effectively at any given time of day, following any news event.

 

We all have our strategies, but it’s important to remember that they might need fine-tuning and altering depending on when we’re trading. You might find that your strategy is particularly effective for the most part, but is prone to considerable failure sometimes. You have to ask yourself what the reasons behind this could be. In many cases, the degree of volatility in a market can flip a strategy on its head. If you can ensure that you are taking volatility into account, and can adjust your strategy accordingly, you’ll find more success.

 

To explain what generally happens when volatility shifts, we need to look at the most common mentality of a forex trader. As already stated, this is an over generalisation, and there are many differing viewpoints, but primarily, the most common trading strategies have the following as their basis. When a traders sees the price dropping down towards a level of support, whatever that might be, and however it has been calculated, the instinct is often there to buy in anticipation of the bounce back up. Conversely, if a price is moving its way towards resistance, then more often than not, a strategy will look to sell before the expected drop.

 

The problem with this strategy is that, when the market becomes more volatile, the price will frequently move outside these levels of support and resistance. When they do, you may well find that you lose out more frequently than you are in profit. The solution to the issue is to not only mitigate the potential negatives of volatility, but to actually capitalise it. The best traders have a way to deal with nearly any eventuality. If you’re one of those people who avoids the market when it’s fluctuating rapidly, then you’re missing out on a considerable amount of trading time.

 

The Breakout Strategy

 

A breakout strategy is widely regarded as one of the most effective methods of trading when prices are capricious. It takes advantage of prices moving beyond given levels of supposed resistance and support. In the simplest terms, when the price moves above resistance, the strategy would have you buy, and when it drops below support, you sell. The rationale behind this is that when things are unstable, they are inherently likely to break above and drop below the levels you’d expect.

 

So what’s the best way of determining the levels at which you should measure support and resistance? Many are of the opinion that a relatively simple Donchian channel is the best method. For those that don’t know, this takes the highest high and the lowest low of the previous x amount of time. One of the most common, and arguably the best length of time from which to take the points of resistance and support, is 20 hours.

 

The strategy is relatively simple then. You have your trading platform plot in the Donchian channel, and then whenever the price moves outside the parameters, you open the corresponding position. It is essential that you monitor things; volatility means that prices will move quickly, and you need to ensure you realise the profit. It’s also prudent to decrease leverage and tighten up any of your stop orders.

 

Measuring Volatility

 

Of course, the secrets to making this strategy don’t end there. If the volatility was low, prices would be likely to move swiftly back within expected levels. If you trade a breakout strategy in these conditions, you’re likely to see more losses then profit. The golden rule then, is to make sure that the market is truly volatile before you switch your methods.

 

There are a number of different ways of measuring volatility, and you should pick whichever you find works the best. Your forex trading platform is likely to come with several different options, but you can always download additional ones. The standard deviation over a given period is the most common way of measuring volatility.

 

A breakout strategy is by no means a fool proof method of making successful trades when the markets are volatile, but it is certainly a very useful starting point if you’re generally very cautious when prices look unstable. If you can take advantage of any given situation, then you’re far more likely to come out with a positive balance sheet.