A scenario to think about. In the morning you wake up to a rainy day. The weather report forecasts a 90% chance of rain all day. Do you plan for a 2 hour bushwalk? Or maybe just stay at home. Based on 90% probability the better decision is to stay at home. In trading FX if you knew the probability of your target being achieved you are also more likely to make better informed decisions.
The Average Daily Range (ADR) calculation is a starting point to analyse the price movement of an FX pair. ADR is an average in pips of how much an FX pair moves over one day. Its formula is as follows:
The number of periods can be 5 days or it can be 10 days. Or even more depending on your preference. For intraday trades lasting for hours rather than days I prefer to calculate the ADR over 5 days.
Starting with candle number 1 we calculate the high minus the low which equals 131 then we do the same for candle number 2 the high minus the low which equals 74 and for the remaining 3 days until we have 5 values as displayed in the table below.
The 5 values are added together and divided by the period of 5 days to calculate the 5 day ADR value.
For simplicity we round down and the result is an ADR of 88 pips. From this result we expect an average move of 88 pips over the next 24 to 48 hours.
Research by ANTSSYS shows a probability of 85% that price will achieve 75% of its 5 day ADR value. This is a useful fact to take into account when using the ADR.
ADR provides a guide as to the possible price range of a currency pair. Knowing the 85% probability rule of attaining 75% of the ADR assists us in setting realistic targets. Used together with your preferred indicators it can improve the probability of attaining your pip goal.
For more on the Average Daily Range, I presented these concepts in a webinar for GO Markets. To view my presentation, click on the button below.