The Forex Average Daily Range (ADR) is a valuable indicator to which every forex trader should pay attention. It is straightforward to understand and use, and can quickly show the daily volatility of selected currency pairs.
What is ADR?
The ADR is simply the average pip range of a currency pair taken over a period of time. If you compare the current ADR to the average value, you can quickly see if the volatility is higher than usual. If this is the case, then the currency pair may be extending beyond its typical range.
We will look at the implications of this later, but first, we will look at how ADR is determined.
Calculating the ADR
Calculating the ADR is very simple, and you can do it on a calculator or simple spreadsheet, though it is calculated automatically on most (if not all) trading platforms.
However, it is worth seeing exactly how to calculate it just to make sure you fully understand how it works. You can set different time frames, but let’s assume you want to calculate it over a week (five days).
Let’s consider the EUR/USD Forex pair. For each day, record the range between the day’s highest and lowest points. Add these together, and divide by the number of time periods, in this case, five.
- Day 1 = 62 pips
- Day 2 = 47 pips
- Day 3 = 72 pips
- Day 4 = 39 pips
- Day 5 = 45 pips
ADR = (62 + 47 + 72 + 39 + 44) / 5 = 53
Thus, ADR = 53.
You may wish to calculate it over different periods, for instance, 10 days, 15 days or even a year (290 trading days).
Using the ADR
For this simple indicator, there is a surprising range of opinions on how best to use it. The first reaction of many traders is that it is a good indicator of when to enter markets.
Unfortunately, this strategy doesn’t always work well. While the ADR indicates an expected value change during the day, it is an “a prori” value. It doesn’t indicate how many pips it will change during a session in the real world; it is merely a statistical average.
Many real-world events can have a significant impact on currency prices that completely dwarf the significance of short term volatility.
While some traders do use it as an entry point indicator, and sometimes they will make the right decisions, there will also be times when their decisions are wrong, so at best they can expect inconsistent results.
Profit targets and stop losses
A more effective way to use the ADR is to set profit targets and stop losses.
Let’s assume that you perceive it is an excellent time to buy a specific currency pair. Before you do so, you should have a target in mind. For instance, how many pips should you aim for, in other words, what is your profit target, and how many pips should you risk on the trade? Ideally, both of these decisions should be within the ADR.
As an example, say the ADR of our currency pair has been 60 pips a day. Clearly, your chances of making a profit of 200 pips is vanishingly small, and setting that as a profit target would be counter-productive.
Similarly, setting a 200 pip stop loss would be pointless. Instead, you should set both within a 60 pip range. By doing so, you are far more likely to achieve your targets and bank your profits.
The Forex Average Daily Range in pips is a useful target which is easy to use and easy to understand. It is helpful for setting profit targets and stop losses, and some traders use it to indicate good times for entering the market. Remember, it is just a statistical indicator and should be used with caution.