Average Daily Range in Action
Ideally adults need between 7-9 hours of sleep each night in order to function well the next day. Some might get less sleep, some more. It’s not an exact figure, more like a guideline. Likewise, the Average Daily Range is a guide for the potential number of pips possible over a specified period. Use it as a profit target in FX trading, not as a guaranteed exact number of pips.
An 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.
The following trade on EURAUD is a past trade using the 5 Day Average Daily Range (ADR) to calculate a profit target.
First step is to calculate the ADR based on the range value of each of the previous 5 days. The range value over one day is simply the high of the day minus the low of the day. Adding the range values from the past 5 days, we divide the total by the period number of 5 days, resulting in the Average Daily Range (ADR).
Research by ANTSSYS shows a probability of 85% that price will achieve 75% of its 5 day ADR value over a 24 -48 hour period. This is a useful fact to take into account when using the ADR.
For the EURAUD trade, the calculated ADR value is 112 pips. There is an 85% probability of reaching 84 pips, that is, 75% of ADR. The open price on the most recent candle in Figure 1, is 1.5789. Target profits are calculated as follows depending on your preferred direction:
Open price + 75% ADR = Target Profit
1.5789 + 84 = 1.5873
Open price - 75% ADR = Target Profit
1.5789 – 84 = 1.5705
From the Daily chart of EURAUD, the lines of the red long-term GMMA are above the lines of the blue short-term GMMA in the order of a general downtrend. Widely separated moving average lines of the long-term GMMA signal strong support for the trend over the long term. The lines of the short-term GMMA have emerged from a compression and are starting to expand out. Opening a 1 Hour chart, we look for an agreement in trend direction and a possible entry.
On the 1 hour chart, Figure 2, the short-term GMMA lines have compressed showing a general agreement in price. Price is expected to break out from this compression and is likely to be in the downwards direction, considering the general trend direction from the Daily chart is down. A short trade position is opened at an entry price of 1.5773 with a stop loss based on the Traders ATR line above at 1.5823 and a Target Profit of 1.5705 as calculated earlier.
Price moved sideways for a few hours after entry before breaking out to the downside. The short-term GMMA expanded out together with the downward price moves. A strong trend was emerging with the widely spaced lines of the long-term GMMA and the short-term GMMA showing support for the downtrend. My trade was closed for 25 pips, marked by the blue star. Traders who continued with the trade wait for 11 hours more before price eventually reached the 75% ADR price of 1.5705. This is provided they didn’t get stopped out by the 2 price spikes through the Traders ATR.
Just as getting less sleep than the guide of 7-9 hours enables you to still function, getting out of a trade before the 75% ADR target enables you to still lock in a profit.
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.