Richard Donchian’s 20 Trading Guides

Richard Donchian’s 20 Trading Guides

Ed Seykota is a legend in the trading world. His ability to produce consistent returns for decades, and his masterful growth of his client’s accounts has earned him a place of distinction. But who inspired this Market Wizard’s trading methods?

Richard Donchian

Richard Donchian didn’t begin his successful trend following system until the age of 65. He was very successful and continued to trade into his 90s. While he operated primarily in the field of commodities, his technical analysis is applicable to any market.

Donchian’s 4 week trading rule system has been at the heart of many successful trading systems, and is one of the simplest and most profitable ways to trade trending markets.  People tend to think complicated is better, but the 4 week rule is a straight forward way of getting you on the right side of a profitable trend. Note that this system was also Richard Dennis’ inspiration for his trading methods, and was taught to the legendary Turtle Traders.

Apart from the 4 week rule, Donchian did work with a five and twenty day moving average crossover signal system, and devised buy and sell rules using a weekly time period.

During Ed Seykota’s interview in the book Market Wizards by Jack Schwagger, Ed describes the influences that Richard Donchian had on his trading system. While Donchian used a five and twenty day moving average cross over system, Ed used exponential moving averages (where more weight is given to the more recent data to calculate the moving average). This occurred in the early 1970s – when computers were new and very slow.  For example, Ed tested approximately 100 variations of four simple trend following systems on a computer was the size of a room, and the tests took him six months to complete.

Anyone who inspired one of the world’s top traders is someone who deserves our attention and study!

Donchian’s 20 Trading Guides (First publication: 1934) General Guides:

  1. Beware of acting immediately on a widespread public opinion. Even if 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 market position is not certain. Clearly defined moves are signaled frequently enough to make life interesting and concentration on these moves will prevent unprofitable whip-sawing.
  5. Seldom take a position in the direction of an immediately preceding three-day move. Wait for a one-day reversal.
  6. Judicious use of stop orders is a valuable aid to profitable trading. Stops may be used to protect profits, to limit losses, and from certain formations such as triangular foci to take positions. 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, 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 (transportation) lead or participate strongly are usually more worth following than moves in which rails (transportation) lag.
  11. A study of the capitalization of a company, the degree of activity of an issue, and whether an issue is a lethargic truck horse or a spirited race horse is fully as important as a study of statistical reports.

Technical Guides:

  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 0n 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 approached, 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.