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Monday, November 1, 2010

Utilizing The Power of Average Daily Range To Trade The Forex Market

Utilizing The Power of Average Daily Range To Trade The Forex Market
Each day in the foreign exchange market has quite predictable times of heavy liquidity and movement.  They are as follows:  (all times are EST)
·         8:00 pm – Asian breakout
·         11:00 pm – Markets settle down and wait for Europe liquidity
·         2:00 am – Early European Breakout
·         3:00 am – London Open brings in heavy liquidity and direction for the day is often established
·         5:00 am – Market settle down and wait for U.S. liquidity
·         8:00 am – New York Open brings in heavy liquidity
·         11:00 am – London traders close up shop for the day leading to potential market reversals
·         2:00 pm – Often a spike in price action as U.S. traders get buys after lunch
·         4:00 pm – U.S. traders close up shop and market remains quiet until 8:00 pm Asian Breakout
Although this schedule is not guaranteed every day, under normal market conditions, these are the times that prices tend to move sharply.  Between 10 am – 2 pm each day, a currency will generally reach its range expansion extreme for the day.  Have you ever thought about the fact that a currency pair does not move an infinite amount of pips each day?  In fact, each currency pair, under normal market conditions, tends to move a rather predictable amount of pips each day.  This amount of pips that a currency pair tends to move each day is known as a currency pair’s Average Daily Range.
Counter-Trend Movements
A trader can use Average Daily Range in several ways.  First of all, it can be used to confirm counter-trend trades.  For example, let us assume the EUR/USD has been moving to the upside in a bullish move all day.  You conduct your analysis and decide that the EUR/USD is coming into a pretty strong area of resistance.  You want to sell the EUR/USD short, and it has moved 130 pips on the day.  Furthermore, you take a look at the Average Daily Range for the EUR/USD and you see that over the last 20 days, it has moved an average of 125 pips.  Therefore, the EUR/USD has exhausted its Average Daily Range, and the probability of it moving further to the upside is not highly probable.  The most probable direction for the euro is for it to move to the downside and come back into its average trading range.
Trend Continuation
The fact is that there are certain days when a currency will up and move way beyond its Average Daily Range.  In these market conditions, which are often caused by unexpected forex news, if a trader were to fade a currency when it came near its Average Daily Range, he would lose a ton of money because, on days like this, the currency may up and move two times its Average Daily Range.  However, traders can actually use the Average Daily Range indicator in order to determine when a currency may move far beyond its daily range.
As a general rule of thumb, if a currency tends to exhaust its Average Daily Range before the New York Open, then the currency pair will generally continue in the direction of its intraday trend and move far beyond its Average Daily Range.  For example, if the Average Daily Range on the EUR/USD is 125 pips, and the EUR/USD moves 125 pips by 6:30 am, then the euro is most likely going to move 200+ pips on the day.  This can be used by traders to take trend continuation signals in expectation that the currency pair is going to move far beyond its ADR on that particular day.
The Average Daily Range, when used properly, can be quite a powerful indicator of trend exhaustion and trend continuation.