The average over n periods of the absolute difference between the high and low of each period.
Most often this is used by traders on Daily periods. So the difference between the High and Low for each day is summed for n periods and then averaged.
There is no magic (or right answer) to the number of periods n should comprise. A common look back period is n=14 (or 14 days) but there is no logic to this. In fact n=15 or n=20 arguably are more logical look back periods as they represent 3 or 4 weeks, respectively, for typical trading weeks.
Average Daily Range
is also known as ADR
Once the ADR has been calculated it can then be applied to the current day's chart which produces an ADR Band with a ADR High and ADR Low. For instance if price opens at 100 and the ADR(20) is 15, then at that point the ADR high is 115 and the ADR Low is 85. The High and Low will dynamically adjust as trading continues throughout the day, eg if price has moved down to 92 then at that point the ADR High will have dropped to 107 and the ADR Low will still be 85.
The ADR High and Low are often abbreviated as ADR_L, ADR-L, ADR L, ADR_Lo, ADR-Lo (and similar for ADR High).
The ADR Bands are often used by traders as a possible profit target or indication when price may have extended itself and be due for a reversal - they are not a trading signal in isolation.
One of the problems with the ADR calculation is it does not take into account gaps in the trading between the look back periods, as it simply taking the difference between the High and Low for each of the n periods and ignores a gap
from the previous period's High or Low. For instance if the High and Low for yesterday were 117 and 100 then the daily range for that period is 17. But the previous day's Low may have been 125, so priced 'gaped' down by 8 points
which are never picked up in the ADR calculation.
To get around this gap problem, many traders use Average True Range
) instead of ADR. A typical software formula to calculate ATR looks like this:
HighLowRange = High - Low
HighToPreviousCloseDifference = AbsoluteValue(High - Last[-1])
LowToPreviousCloseDifference = AbsoluteValue(Low - Last[-1])
TrueRange = max(HighLowRange, max(HighToPreviousCloseDifference, LowToPreviousCloseDifference))
[source for formula: http://www.sierrachart.com/index.php...nce.html#s107]
The ADR and ATR can be calculated for either ETH
, although it would seem a calculation based on ETH is the most logical eg if the RTH ATR is 12 and the ETH ATR is 16 for a given instrument, and overnight
price has already moved by 10, then it seems unlikely price will move by another 12 during the RTH session.