This post will try and explain average daily range trading on currency as best as i possibly can. I will start from a monthly application then move to weekly and finally to daily to try and explain the concept...
Basically the concept of ADR trading is to always have a 2:1 risk reward and so you know levels where you might look at taking profit. Enter within 25% of the range exit at 75% = 2:1 risk reward...simple? It is what works for me and what i have been taught but harder to implement. I have never really done it much on currency trades but was interested to see its application so this post will try and demonstrate the concept.
Basically what you want to do is let price go down or make a low and then once it comes back through the open (think of a candle and the wicks) then you will take a long position and stops below the lows. Should the candle make a high and fall through the open we take a short position.... We want the price to go down only 25% of the ADR so max the price can go down from the open is 25%. We never want to risk more than 25% of the ADR if we are going to trade this method otherwise your risk reward is not good. (sometimes i allow 33% but stick to 25% for now) so for these examples i use the aussie dollar as the currency we will follow. I use IG markets custom indicator to give me the ADR. (below)
So here we have a ADR of 640 pips on a MONTHLY for the Aud/Usd so the max risk of this should be 25% * 640 = 160 pips. the open for the month is 0.8415 so we are allowed to let price fall a MAXIMUM of 8415 - 160 = 0.8255 is the max risk we are allowed. If price makes a low below this we could not enter and need to wait for the next month but we can still use the weekly and daily ranges for trades. But on a monthly we will look and see what limit and projections price can get to...
Ok i will now try and demonstrate with the charts how this could be applied... I should also say it is generally better when you have a clear indication of what u think the market could do but once price has come through the open on be it a monthly, weekly or daily basis i can apply the ranges to give me target levels and failure levels (50%) but i will show this once i have given a better understanding of the concept...
First i will start with a MONTHLY ADR. the Range Which is the high - low of the last 20 months and the AVERAGE of this. So 20 months the average of the highs - lows or range which is (according to IG markets) 0.0639 so say 640pips in a month (see picture above) is 100% of the range. So the low of this month (July) is 0.8315 (according to GFT) So from this low we would add 640 pips. This will be 100% of the range. This target level takes it to 0.8955. Ok so lets look back now at the charts.
This chart shows a monthly with the candles. I have marked the open the lows and then price coming back up through the open. WE can see it is coming of a 61.8% fib level so if we are BULLISH on the AUD we would take this long on a POSITION trade and look for our 75% and 100% target levels based on the ADR which is to the 0.8955 level... lets remember that is where we are looking to take profit and this is our POSITION trade. We entered as soon as price moved back through the open and stops at the lows or at the 25% level of the ADR (should normally be around support/res levels as well. So we enter the trade at 0.8415 through the open with stops at 0.8314 lows... That is a risk of 101 pips and initially we would look for 75% level as target which would be (ADR 640 * 75% = 480. Lows of 8315 + 480 = 0.8795 target) That is still a risk reward of over 4.5 times! Now we can move into a weekly and see those trades...
WEEKLY: ADR = 320pips
Here the open is 0.8417 and we are allowed 25% of 320 = 80pips risk.
The lows here are 0.8316 so this is 8417 - 8316 = 101 pips of risk. Which is outside of our 25% risk. (this is why i sometimes use 33% as this allowed 105 pips to the lows and if you are confident in the position and trade you can do this also but keep it tight!) So say we take this trade based on the 1/3 or 33% of the ADR we would enter when price went through the open at 0.8417 and stops at the lows - 1 pip so 0.8315 stops so a risk of 102 pips to potentially gain a 100% or 320 pips or 75% of 320 which is 240 pips still over 2:1 risk reward.
This chart below shows the weeks in question...
So here we are now looking for a target of say 75% initially which would take us to 0.8556 (Lows + 75% of weekly ADR) 8317 + 240 = 8558. Should price be going through this we could take 100% and accept no less than 75% or 50% of the ADR and keep moving stops up. 100% takes us to (8317 + 320 = 8637) As we can see the highs of this week got us to 0.8791 which well exceeded the 100% of the range and if we were using trailing stops we would have captured a huge move that netted us a lovely profit!!
I wont go through the other week but i will now zoom into a daily and show you how that apply's there and how it can be used for the weekly and monthly targets...
That image shows the Monthly 100% target and where you would take and entry based on the daily candles as it has made lows and passed through the open. We are bullish and that is our direction so we look to the target levels. It is within 25% of our monthly ADR so we take the trade.
The first week of july doesnt look pretty and for a weekly trade it exceeds the entry criteria after the first 2 candles so i didnt go into details there as can get confusing. Lastly i will show the daily candles and ranges these are the ones you can try focusing on as when you move down time frames it can get difficult to understand where you would enter etc but that was the ranges on a bigger scale and to show you the application. Certainly a daily is where they all begin so start here and maybe just use the DEMO account to practice these if anyone feels the need.
The daily ADR is around 105pips on the A/U. So you are allowed to take an entry within 25% of this as long as price pushed back through the open then you look for 75% as first target as per the examples on the monthly and the weekly... So 25% is 26pips and 75% is 78pips. So apply the same rules. From open - 26 pip is within there and pushes back through open take it long or if it falls through take it short and exit within 78pips which is from the low. (Low + 78 = 75% of the range)
The picture above i have demonstrated which trades you would be taking on a daily perspective for the ADR to work. These are generally all within the 25% rule or very close. The moved through the open and you would take the trades long or short as indicated. You can see the ones that create wicks if you work out your exits you would be surprised how nicely your profit taking levels of 75% work. Generally if these are around the support and resistance levels or pivots then just work as ideal levels to take your profits.
I have put on there how many pips were potentially made throughout the month using only that strategy on those days. That does not include the pips you would make on a monthly and weekly trades which i will leave to you guys to work out from the charts i put earlier on in the post.
There are a few other rules you can use with your ADR trades such as. Once you have reached the 50% level of the trade put your stops to your break even as once your risk = reward you should never let it turn into a loss. Also move stops up as you hit target levels if you dont want to take profits. Generally once it is through the 75% level i wouldnt accept much less than 75% as sometimes it can fall all the way back down. But other times it can run to over 150% of the range so its about knowing when to let your profits run and when to cut them. But this takes time to work out and you can use trailing stops if you like. But this is up to the users discretion...
HOPE that was not to much reading and i feel like i just typed for a decade trying to explain that. I wouldn't recommend jumping for joy and going all crazy on the strategy as it is hard to master but if you have your basic technical analysis mastered then you can give it a shot.
Hope it was interesting and thats an insight to how i have been taught to trade.
If you want to see more i recommend looking at 'tradethetrade' channel on youtube as he posts some excellent videos more on stocks than anything but it is the same concept and he is who taught me what i know!!
Link: http://www.youtube.com/user/TradeTheTrade
Anyway guys peace out and have a GREAT weekend. Lets see if we can make as many pips in August!!!
:)
