Donchian’s Trading Guidelines

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Richard D. Donchian is a well-know Wall Street technician of recent times. He is also known as the father of trend following. Many modern trend following systems, such as the Turtle Trading system, are based on his work.

Based on his experiences over time, Donchian developed 20 trading guidelines split into two groups: eleven general guidelines and nine technical guidelines. These guidelines provide deep insight to traders in any type of market.

These guidelines are listed below however they have been paraphrased for a clearer explanation.

Donchian’s General Guidelines

1. Beware of acting immediately on widespread public opinion. Even if it is correct, it will usually delay the move.

2. From a period of dullness and inactivity, watch for and prepare to follow a move in the direction in which volume increases.

3. Limit losses and ride profits, irrespective of all other rules.

4. Light commitments are advisable when a market position is not certain. Clearly defined moves are signalled frequently enough to make life interesting, and concentration on these moves to the virtual exclusion of others will prevent unprofitable whipsawing.

5. Seldom take a position in the direction of an immediately preceding three-day move. Wait for a one-day reversal.

6. Judicious uses of stop orders are a valuable aid to profitable trading. Stops may be used to protect profits. Stop orders are apt to be more valuable and less treacherous if used in proper relation to the chart formation.

7. In a market in which upswings are likely to equal or exceed downswings, a heavier position should be taken for the upswings for percentage reasons; a decline from 50 to 25 will net only 50% profit, whereas an advance from 25 to 50 will net 100%.

8. In taking a position, price orders are allowable. In closing a position, use “market” orders.

9. Buy strong-acting, strong-background commodities and sell weak ones subject to all other rules.

10. Moves in which rails lead or participate strongly are usually worth following more than moves in which rails lag.

11. A study of the capitalization of a company, the degree of activity of an issue and whether the issue is a lethargic truck horse like Consolidated Edison or a spirited, volatile race horse like Case Threshing Machine is fully as important as a study of statistical reports.

Donchian’s Technical Guidelines

1. A move followed by a sideways range often precedes another move of almost equal extent in the same direction as the original move. Generally, when the second move from the sideways range has run its course, a counter move approaching the sideways range may be expected.

2. Reversal or resistance to a move is likely to be encountered

  • On reaching levels at which in the past, the commodity has fluctuated for a considerable length of time within a narrow range
  • On approaching highs or lows

3. Watch for good buying or selling opportunities when trend lines are approa ched, especially on medium or dull volume. Be sure such a line has not been hugged or hit too frequently.

4. Watch for “crawling along” or repeated bumping of minor or major trend lines and prepare to see such trend lines broken.

5. Breaking of minor trend lines counter to the major trend gives most other important position taking signals. Positions can be taken or reversed on stop at such places.

6. Triangles of ether slope may mean either accumulation or distribution depending on other considerations although triangles are usually broken on the flat side.

7. Watch for volume climax, especially after a long move.

8. Don’t count on gaps being closed unless you can distinguish between breakaway gaps, normal gaps and exhaustion gaps.

9. During a move, take or increase positions in the direction of the move at the market the morning following any one-day reversal, however slight the reversal may be, especially if volume declines on the reversal.

Conclusions

In conclusion we can say that three themes clearly emerge out from these rules. First, direction of the underlying trend determines position preference. Hence, traders should focus on long positions during an uptrend and short positions during a downtrend. Second, volume plays an important part in the analysis process. Therefore, price moves in the direction of the bigger trend should be on higher volume, while counter trend moves should be on lower volume. However, it may be noted that volume climaxes can mark the end of an extended move. Third, trading ranges and consolidations are important chart patterns. While long consolidations can mark reversals and future support or resistance levels, short consolidations frequently mark a rest in the ongoing trend.

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