Rajandran R Founder of Marketcalls and Co-Founder Algomojo. Full-Time Derivative Trader. Expert in Designing Trading Systems (Amibroker, Ninjatrader, Metatrader, Python, Pinescript). Trading the markets since 2006. Mentoring Traders on Trading System Designing, Market Profile, Orderflow and Trade Automation.

Richard Donchian’s : The 4 Week Rule

2 min read

The 4 week rule, developed by Richard Donchian, is one of the most successful systems tested by time. The 4 week rule is used primarily for futures trading but might also work in your stock trading system .The Turtles used the same strategy in the eighties. Donchian's strategy was to "buy when a stock made a 4 week new high" and his exit rule was " sell when it makes a two week low". This system is simplicity at its best:
1)Cover short positions and buy long whenever the price exceeds highs of the four preceding full calendar weeks.
2)Liquidate long positions and sell short whenever the price falls below the lows of the four preceding full calendar weeks.
The four week rule has proved to be an effective building block on which many successful trading systems are based.

It's based on the following assumptions about market behavior:

1. The strongest trending moves start from new market highs NOT market lows.

Those people who think buy low sell high is a great way to make money are wrong. If you don't buy breakouts from new highs, you will miss some of the best trends – period.

2. A trend in motion is more likely to continue than reverse.

We all know this is a basic building block of technical analysis and there is no better trend than one that is making new highs

3. A four week cycle is the dominant cycle in trading.

This can vary at times of course but the four week cycle is highly effective.

The original rules were used for trading commodities and can be summarized by:

Cover short positions and buy long whenever the price exceeds the highs of the previous 4 calendar weeks.

Liquidate long positions and sell short whenever the price falls below the lows of the previous 4 calendar weeks.

The original system being devised for commodities was designed to use a stop and reverse so the trader was always in the market with a position.

In a non trading market it can get whipsawed a solution to this problem is to enter on the 4 week rule (the breakout), and to exit on a shorter time period such as 1 or 2 weeks. With this system, a four week "breakout" would be needed to initiate a new position, but a one or two week signal in the opposite direction would mean liquidation of the position.


The trader then remains out of the market until the next new four week breakout is registered.

Why It Works

This system is based on sound technical principles with signals that are mechanical and clear-cut. It is trend-following so a trader is virtually guaranteed to be on the right side of every trend.

It also follows the often quoted trading wisdom – "let profits run, while cutting losses short". Another advantage is fewer trades, which means less time being spent looking at the market and finally you don't even need a computer!

People often say technology helps – but for many traders its a hindrance they think being clever will make them money, well consider this 95% of traders lost 100 years ago and the its the same ratio before yet computers today are more powerful than the one mission control used to land man on the moon!

Don't be fooled by simplicity it can be very profitable.

Being a trend-following system, it is not going to catch market tops and bottoms ( but how many systems do that though?) however, the 4 week rule works as well as any other trend-following system but with the benefit of incredible simplicity.

The Proof

You might be saying that won't work – well go and try it on a strong trending currency market like the euro, Canadian dollar or Australian dollar and back test it and in a number of strong trending markets and you will see it does.

Don't be led to believe that if its simple it won't work – all the best forex trading systems are simple.

You don't get paid for being clever you get paid for being right – Period.

Today, traders always like to trade something different or obscure but if you want a simple system, by a trading legend, that's hard to beat – try Richard Donchian 4 week rule It's been part of some of the true great traders box of tools and should be in yours to.

 

Rajandran R Founder of Marketcalls and Co-Founder Algomojo. Full-Time Derivative Trader. Expert in Designing Trading Systems (Amibroker, Ninjatrader, Metatrader, Python, Pinescript). Trading the markets since 2006. Mentoring Traders on Trading System Designing, Market Profile, Orderflow and Trade Automation.

GANN Shorter term update for Nifty as on 15…

  GANN Supports zone near 5005. More weakness below 5005 as next support near 4780. Avoid longs if nifty dips below 5005. Source: www.marketcalls.in
Rajandran R
5 sec read

Larsen and toubro update

  Trailing Stop Loss Update for Larsen and Tourbo   Cover Shorts and reverse the position if LT closes above 1665. Source: www.marketcalls.in
Rajandran R
6 sec read

JP Associates is getting Weaker

  1)Stock is showing massive MACD divergence 2)Price is currently below 13,34,55 EMA and these levels could act as a resistance in coming sessions. 3)Stop loss...
Rajandran R
12 sec read

4 Replies to “Richard Donchian’s : The 4 Week Rule”

  1. Hello, thank you very much for great information.I am looking everywhere for Donchian strategy detailed rules but have not been able to find. Everything is just guidelines like above. Could you let us know where we can find these rules?Thank youe-mail: shpinserge@yahoo.com

  2. I made a system like that, a Donchian breakout system that enters on 120 day high and exits when it doesn't make a new high for 12 days. This keeps you in while the trend remains but doesn't give half the profits back waiting for a new low. Due to not giving back the profits, this system has a win ratio of 50%+I've back tested it on five major currency pairs since 1999 and posted the full results here http://www.myforexdot.org.uk/StrangeCurrenciesSystem.html

Leave a Reply

Get Notifications, Alerts on Market Updates, Trading Tools, Automation & More