Tim Olson
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61 lines
3.3 KiB
Markdown
61 lines
3.3 KiB
Markdown
---
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description: "Buys at the channel floor and shorts at the ceiling (mean-reversion), or follows breakouts through channel boundaries (trend-following), using a Donchian Channel defined by T-period price extremes."
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tags: [stocks, technical-analysis, channel, donchian, trend-following, mean-reversion]
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---
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# Channel
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**Section**: 3.15 | **Asset Class**: Stocks | **Type**: Technical Analysis (Mean-Reversion or Trend-Following)
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## Overview
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A channel (band) strategy uses a price range bounded by a ceiling and a floor within which the stock price fluctuates. The most common definition is the Donchian Channel, where the ceiling is the T-period maximum price and the floor is the T-period minimum price. The trader can either fade moves to the channel extremes (mean-reversion) or follow breakouts through channel boundaries (trend-following).
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## Construction / Signal
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**Donchian Channel** (Donchian, 1960):
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```
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B_up = max(P(1), P(2), ..., P(T)) (329)
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B_down = min(P(1), P(2), ..., P(T)) (330)
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```
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where P(t) is the stock price, t=1 is the most recent day, and T is the channel lookback period.
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**Mean-reversion signal** (fade the extremes):
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```
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Signal = { Establish long / liquidate short if P = B_down
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{ Establish short / liquidate long if P = B_up (331)
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```
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The expectation is that if the price touches the floor or ceiling, it will bounce back toward the center of the channel.
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**Trend-following variant**: If the price breaks through B_up (ceiling), the trader may interpret this as the start of a new uptrend and go long instead of shorting; if it breaks through B_down, go short.
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## Entry / Exit Rules
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**Mean-reversion mode**:
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- **Long entry**: Price reaches channel floor B_down.
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- **Short entry**: Price reaches channel ceiling B_up.
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- **Exit**: Close when price moves toward the center, or at a fixed time horizon.
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**Trend-following mode (breakout)**:
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- **Long entry**: Price breaks above B_up (new trend upward).
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- **Short entry**: Price breaks below B_down (new trend downward).
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- **Exit**: Wait for channel break in the opposite direction.
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## Key Parameters
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- **Channel period T**: Number of trading days for computing the min/max (typically 10–55 days)
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- **Channel width**: Wider channels (longer T) reflect higher volatility; narrower channels = tighter bands
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- **Mode**: Mean-reversion (fade) vs. trend-following (breakout)
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- **Volume confirmation**: Signal robustness improves when price extremes coincide with increased traded volume
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## Variations
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- **With volume filter**: Signal is more robust when a price reversal or breakout occurs alongside increased traded volume
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- **Bollinger Bands**: Channel defined by moving average ± N standard deviations (alternative to fixed min/max)
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- **Keltner Channels**: MA ± N * ATR (average true range)
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## Notes
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- The wider the channel, the higher the implied volatility of the underlying stock.
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- The channel indicator is typically used together with other signals (e.g., volume) rather than in isolation.
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- Mean-reversion mode assumes the price will bounce off extremes; trend-following mode assumes a breakout signals a new trend.
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- The strategy can be applied single-stock or across a universe; with a large universe, near-dollar-neutral portfolios are possible.
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- Donchian Channels are a classic component of the "Turtle Trading" trend-following system.
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