How to use the Average Daily Range in Forex
The average daily range (ADR) is an indicator that shows you the historical average of each day’s range (high – low). In this article, we will cover:
- How to calculate the average daily range
- How to use the average daily range in your Forex trading
- Average vs confidence values
- Why confidence values are important and how to use them
- A free average daily range indicator for Metatrader 4 (MT4)
- The distinction between Average Daily Range (ADR) vs Average True Range (ATR)
How to calculate the average daily range?
The ADR is calculated by simply summing the daily ranges (a daily range is the difference between the day’s high and low) and dividing it by a certain number of days, thereby averaging out the daily range over this time period. Typically, 21 days or 30 days are used as the ADR’s period in an ADR indicator.
How to use the average daily range in your Forex trading
This indicator can be used to gauge the volatility and to decide whether to trade a pair or sit out on the sidelines.
When today’s range gets to a value near the average range – for example, if the average is 100 pips, and today’s range is already at 90 pips – it might be wise to consider not trading the pair any longer for the day and instead look for opportunities in other pairs, as it already reached the historical volatility.
But let’s say that you’ve found the setup you were looking for, yet the daily range is already close to its average! So as not to miss a potentially lucrative opportunity, there is another value you should look at in these situations – the confidence levels.
Average vs confidence level
So what is a confidence level, and how does it relate to the average?
A confidence level of 90% with the value of 200 pips for example, means that 90% of the times, the daily range will be below 200 pips. In other words, the daily range will be at most 200 pips with a 90% confidence.
Typically, the 70% confidence level and above will be a higher value than the average. Whereas, the 50% confidence level is called the median, and typically it’s fairly close to the average as long as the averaging period is long enough. In certain situations it can deviate significantly from the average though (especially when there have been recent highly volatile days), so it’s good to keep an eye on both the average and these confidence levels.
How to use the confidence levels
You can use a confidence level of 75% to 90% instead of the average in those situations where you have a good reason to believe the pair still has room to trend, such as in days when:
- There was a news event with a major impact
- Prices broke an important Support/Resistance
- The pair has been on a strong trend for the last few days
In these situations, the average might not be a good “bet” on where the day’s range will reach, and so, using a high confidence level could make more sense.
Average daily range (ADR) vs Average true range (ATR)
These two terms may sometimes generate confusion, but they are distinct indicators that measure different things:
Average daily range (ADR) – average of the daily range (range = high – low).
Average true range (ATR) – the average bar’s “range” (range = high – low). So the difference is that unlike the daily range, it may use other timeframes other than the daily one. So we can speak of the ATR of EUR/USD 15 minutes timeframe, or the 1-hour timeframe for example.
On that note, the ATR of daily timeframe, would be a very close (or equal) value to the ADR.
Why not exactly equal? Because the ATR also takes into account price gaps. So unlike the ADR, it does not average over ranges, it averages over true ranges.
What is the true range?
For example, if yesterday’s high was 1.0500, but on the next day the low/high were at 1.0600/1.0700 respectively, there would be a gap between the two bars. And so instead of calculating today’s range as simply the high – low:
Range = 1.0700 – 1.0600 = 100 pips
You would use the previous day’s high instead:
True range = 1.0700 – 1.0500 = 200 pips
This way, the volatility between different bars is also taken into account, and for that reason, there is typically a small difference between the average range and average true range.
Get a free average daily range (ADR) indicator for Metatrader 4 (MT4)
We have a free average daily range indicator available, called AT – Daily Range, that also includes the confidence levels mentioned above. Along with showing all these values, it conveniently plots the expected daily high and low based on the average.