Envelopes and Methods of Price Containment
maximize longer‐term profitability, all risk‐free positions should be allowed to run
over longer periods in the market, scaling out some profit along the way.
As far as channel periodicities are concerned, the most popular lookback pe-
riod for a price channel is probably 20 periods. This may be attributed to Richard
Donchian’s four‐week price channel, which equated to a 20‐day trading period.
Even the famous Turtle traders used a form of price channeling with incredible
success in the markets. Richard Donchian used a 20‐day lookback period for the
price channel because he was trying to track a four‐week commodity cycle in the
market. See Figure 12.24 for an example of a typical bidirectional price channel
signaling long and short re‐entries.
One serious disadvantage of using price channels is that it does not take into
account any significantly clear and obvious support or resistance that may be in
proximity with a new channel entry. We clearly see this occurring at Point 4 where
a long entry was initiated just below a clear and obvious resistance level created
near the middle of May 2013. This weakness may potentially lead to many pre-
mature entries.
Being trend following by construction, price channels tend to work better in
stronger trends. They perform very poorly in consolidations. In fact, unless the
trend is strong enough, price channels tend to perform relatively poorly. The chart
in Figure 12.24 shows a series of bidirectional trades. The short entry at Point 1
was exited at Point 2 for a loss. A new long was established at Point 2, which was
exited at Point 3 for a small gain. A new short established at Point 3 experienced
another loss when it was exited at Point 4. Needless to say, the new long position
initiated at Point 4 was exited with a loss at Point 5. In such a situation, it is obvi-
ous that a 20‐period lookback is inappropriate across the period of observation
in Google.Figure 12.24 20‐Day Bidirectional (SAR) Price Channel Signaling Long and Short
Re‐Entries on the Daily Chart of Google Inc.
Courtesy of Stockcharts.com