The Richard Donchian 4-week theory is a well-known strategy used by most professional traders. Although I personally prefer automated software, the 4-week theory is a manual strategy that I use to gain profitable results.
Time-Tested Strategy
The Donchian 4-week theory has been around for more than 30 years and it is a proven strategy. Due to its straightforward nature, some traders underestimate its profitability. Yet, the 4-week rule has remained profitable since it was first introduced in the commodity market and continues to be effective today. It works well in Forex, commodities, and stocks.
How Does It Work?
The Donchian theory challenges the “buy low and sell high” concept. Even experienced traders can miss selling at the highest point and buying at the lowest one. Instead, the Donchian theory uses a 4-week rule to determine when to enter a trade. Go long when the price of a trending currency pair rises above its highest point of the past 4 weeks, or short when it falls below its lowest point of the past 4 weeks. Applying this theory enables you to catch all the significant trends that last for weeks or even months.
Why Does It Work?
The Donchian 4-week rule is a simple breakout methodology based on price action. Long-term trends in currency pairs can last from weeks to years, and you can closely observe the trend’s development through repeated breakouts of either new highs or new lows depending on the market’s direction.
The methodology is rock-solid since it only focuses on 4-week highs and lows, which enable you to capture and maintain long-term trends. Long-term trends are the ones that generate consistent profits, and this holds true for the Forex market, which is very profitable using the 4-week rule in the long-term.
A downside to this theory is that it is ineffective in sideways or consolidating markets, and it even generates losses. One way to avoid losses is to trade uncorrelated markets when applying this rule.
Conclusion
The 4-week rule turns trades in favour of the opposite to what most traders expect. Though this may appear counter-intuitive, it’s crucial to bear in mind that 95% of Forex traders lose money. Being in disagreement with the majority can signal a good trade. No automated system based on the Richard Donchian theory exists to date. Since this theory is elegantly simple and consistently profitable, it’s worth adding to your trading toolbox.
Written by Luis Nieves