Tag Archives: ADR/Spread ratio

Efficent Forex Day Trading with Volatility

Efficient Forex Day Trading by calculating the volatility

This article provides you some statistical data and suggestions to optimize your trading results especially when you like to trade intraday. When you trade intraday every pip counts and therefore you should carefully choose at what time of the day to trade and what pair. Intraday traders try to scalp the market with rather small targets and rather small stop loss levels. Usually the target will be anywhere from 10-50 pips and so will be the stop depending on the current volatility and technical support and resistance levels. The spread is the one the biggest enemies of a scalping trader. Let’s say your spread is 2.5 pips in the GBP/USD. The price has to move 12.5 pips in your direction for a +10 pip trade but only has to move 7.5 pips against you for a -10 pip trade. You see that your hit ratio has to be sky high to be a profitable scalper who is just looking for 10 pips here and there. The best way to avoid the “spread trap” is obviously to go for larger targets and stops since the spread becomes less an issue percentage wise. But for potential large targets you need to trade pairs with a large average daily range. Trading those high volatile pairs might still not be the best choice since those pairs often come with a huge spread. To trade cost-effective you have to look for the pairs which give you the best intraday potential in relation to the costs of trading them. You calculate the recent volatility of a given currency pair and divide the result by the spread the broker is giving you on that pair. Let’s say the recent average daily range of GBP/USD was 150 pips. If your broker has a 3 pip spread on that pair than your average daily range/ spread ratio would be 50. (150 pips/3) So you want to look for pairs with a high ADR/Spread ratio.

The table shows you the pairs with a simple 10 week average daily range, the actual spread on my broker and the ADR/Spread ratio. The ADR is calculated as of April 5th 2011.

Pair ADR(10 W) Spread ADR/Spread Ratio
EUR/USD 126 1,3 96,9
EUR/GBP 67 1,3 51,5
EUR/JPY 136 2,2 61,8
EUR/CHF 125 2,2 56,8
GBP/USD 137 2,3 59,5
GBP/JPY 167 2,5 66,8
GBP/NZD 257 9 28,5
GBP/CHF 173 3,7 46,8
USD/JPY 82 1,3 63
AUD/USD 87 1,7 51,2
USD/CAD 74 2,4 30,8
USD/CHF 99 1,8 55

As you can see EUR/USD gives by far the best ADR/Spread ratio and makes this therefore the best intraday pair to trade on my broker from a cost effective perspective. If you have 2 pips spread on EUR/USD the ratio would drop to 63 which is still pretty good. Some high volatile pairs like the GBP/CHF and GBP/NZD have the worst ratio with their high spread costs. Keep in mind that this table might look different with your spreads but calculations can easily be done with a little homework. You can find the ADR either by looking it up various websites or you can use and indicator for your charting software.

Time is money is this is especially true for trading. Sometimes we sit for hours in front of our screens and the market is just a snooze fest. You can argue that we need a nice trend to trade profitable but all traders need volatility. If the price just trades in a tight range trading becomes not only boring but you also ineffective. To get more of your hours in front of your charts you should only trade when there is a good chance that we will see any movement. Of course that is never any guaranty in trading but looking at the past might give us hint when we should trade or just leave our screens. When I trade on a Monday and Friday I got the feeling the market moves always somewhat slower compared to the other days of the week. But is that true and can be backed up by statistical evidence? Let’s take a look at the EUR/USD Volatility per weekday in the last 10 weeks.

EUR/USD Average Daily Range per weekday (10 weeks)

It looks like my feeling was right about Mondays but Friday is actually the most volatile day of the week behind Thursday. The high volatility on Friday could mislead though since we have some of the most important news events on Fridays like the NFP number. But this graph shows clearly that volatility is picking up after Monday since some institutional players enter the market on Tuesdays after looking at Mondays trading in hope to get some info about the possible direction for the rest of the week. The volatility on other pairs looks even worse on Mondays. Here is the USD/CHF:

USD/JPY Average Daily range per weekday (20 weeks)

As you can see the day of the week with the highest volatility might change with a different pair, but Monday is for all pairs the day with the lowest volatility. If you don’t like slow days I recommend to skip trading certain pairs on Mondays at all. Note also that the ADR/spread ratio drops dramatically on a Monday. Let assume you have a 2 pips spread on USD/JPY. The ratio on a Monday is 26 (52/2) while the ratio is 44 on a Wednesday and Friday. It can be very useful to look at the historic volatility on your favorite pairs to trade. If you trade intraday you won’t just be interested in the weekdays but in the daily hourly volatility. Below you see a graph showing you the average pip range (10 weeks) of the EUR/USD separated by the daily hours. As you can see the best volatility is between 8:00 and 11:00 GMT and between 13:00 and 17:00 GMT.

If you trade intraday your trading hours should be within the hours of the day with the highest volatile. You don’t want to sit the whole day in front of your screen. If you want to choose your hours to trade even more detailed you could even calculate the best trading hours on certain weekdays. You can use this kind of statistic also for your stop loss levels. Volatility stops can be quite effective since putting a stop beyond the expected volatility gives you a good chance not to get stopped out in most cases. I will write a separate article on how to use volatility stops in praxis.