The Richard Donchian 4-week theory is a time tested strategy that most professional traders use. Although I prefer to use automatic software to do my trading, the 4-week theory is one of those non-automated strategies that I use to make consistent profits.
After 30 years still going strong
The Donchian 4-week theory is a proven strategy that has been around for over 30 years. Due to its simplicity, many traders disregard it because they don't believe it can be profitable. The reality of it, however, is that the 4-week rule has been making money since it was first introduced in the commodity market more than 30 years ago and it still makes tremendous profits today. This theory works well in any type of market whether is Forex, stocks, or commodities.
How does it work?
The Donchian theory goes against what most traders believe to be main rule of trading “buy low and sell high”. Although it is true that, if you can identify the highest point to sell and the lowest point to buy you will profit, the reality is that those points can escape even the most seasoned of traders. The Donchian theory uses a 4-week rule to determine when to enter a trade. By simply going long when the price of a trending currency pair goes higher than all the highs of the past 4 weeks and, conversely, by going short when the currency pair goes lower than all the lows of the past 4 weeks. If you learn how to apply this theory, you will NEVER miss any of the big trends which last for weeks or months again.
Why does it work?
The Donchian 4-week rule is a simple price action strategy that is based on breakout methodology. When you look at currency pair charts, you will see that long trends can last weeks, months, or even a year or longer. A closer look will clearly reveal how these trends start and continue by continually breaking to new highs if the market is bullish or by breaking to new lows if the market is bearish.
The methodology is really solid. Since it is only interested in 4 week highs and lows, the system will catch and hold long term trends. In terms of making money, long term trends are the ones that consistently make the big profits. The Forex market is not exception when applying the 4 week rule and is very profitable over the long term.
One disadvantage to the Donchian theory is that it doesn't work on markets that are sideways or consolidating. As a matter of fact, on sideways markets the 4-week rule will lose money. A way to prevent these loses is to trade uncorrelated markets when using this rule.
The 4-week rule generates trades when the majority expect the opposite to occur. Although this may seem like a bad thing, it really isn't. Keep in mind that 95% of Forex traders lose money so being in disagreement with the majority is probably a good indication that the trade taken is good. To date, I haven't seen a single automated system that is based on the Richard Donchian theory and, since it is beautiful in its simplicity and proven to make profits consistently, you should include it in your trading toolbox.