ATR (Average True Range) vs. ADR (Average Day Range) | What they don't tell you

I was having this conversation with a coachee of mine, who was bent on using ATR instead of ADR as a reference for trading and I had to help him understand the difference and the context as to what is relevant where, and why I lean towards ADR. Below is an excerpt of what I told him.

The case for ADR

First things first - What is ADR - ADR is simply the average of intraday (High-Low) value. This excludes Gaps.

So - What is ATR? - Here is a better explanation. Essentially ATR is a range calculation which includes Gaps as it calculates from PDC (Previous Day Close).

So it essentially boils down to the significance of Gaps.

Let’s digress a bit to understand why do we use Range as a reference.

To me Range is a good indication (of / or a proxy for) volatility. You will see that for yourself, if you follow VIX, as VIX increases, so does range (Ref. the plot below). By including Gap in the calculation we may get an incorrect and irrelevant view of the intraday volatility.

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Based on Past 60 Days’ data - NIFTY Futures and INDIAVIX

As an Intraday trader I am concerned only about what happens between the Open and Close. That is what is my playing field. I am not a positional trader to take advantage of or get affected by Gaps.

So the next question to ask is? Is there a correlation between the size of the gap and the ADR for the day? This would determine if including GAP data helps us in any way.

I did a quick math by calculating the Correlation Coefficient with Gap size as an independent variable and (ADR) Range as a dependent variable and I get a score of 0.36. Take a look at the scatter-plot below.

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Based on Past 60 Days’ data - NIFTY Futures

As you can see there is no linearity in there.

So given that there seems to be no correlation between Gaps and ADR, I would recommend using ADR and not ATR,

ATR is relevant in markets or products were Gaps have a correlation with Range, which does not seem to be the case with NIFTY.

However, I do keep an eye on the Gaps, but that is more from a perspective of understanding if there is a visible change in the market structure, more on it later.

Here is a snapshot of the data that I reference during the day. It gives me a clear sense of the developing range with references of Previous day and a 20 day Look back period.

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Snapshot of NS-RangeByTime Indicator for NT8

NiftyScalper | StatShot - 03 | High Low Markers

One of the reference points for Mean Reversion and Range Extension trades is the High and Low reference of the day w.r.t time. Here is a set of stats which helps us take a probabilistic view of the day structure. 

The hypothesis that we tried to test here was - How often does the High or Low marked x minutes after the market open remains so for the rest of the day?

Y axis in % | X axis in Minutes - Data - 847 Trading days till Nov'17

NiftyScalper | StatShot - 01 | High/Low Time Segment

Starting a new series here on the blog called "StatShot". The idea is to bring to you statistics based snapshots of NIFTY. Be warned that you cannot use these in isolation for your trading, it has to be used in a specific context while creating your strategy or setups.

Coming to our first 'StatShot' in the series. Let's took at what I call the 'High/Low Time Segment'. As an Intraday trader one of the key things is to determine your supports or resistances, and to do that you need to know when (at what time i.e.) does an index mark its high or low during the day. Of course you could slice and dice the data to get to more nuanced stats and probabilities.

So heres's how it looks like for NIFTY

Based on NIFTY Data (2014 to 2017) - A through F constitute 1 hour each and G is 15 min

With this info. you can take a probabilistic call as to where your supports and resistances lie.

Hope this helps.

Trade Safe.