Have you ever wondered what the Average True Range indicator is and how it can help you become a better trader? In this blog post, we’ll provide an overview of the Average True Range and explain how you can use it to improve your trading results. Stay tuned for more tips and strategies to help you become a successful trader!
What is the Average True Range (ATR)?
The average true range (ATR) is a technical indicator that measures market volatility. It was developed by J. Welles Wilder and introduced in his 1978 book, “New Concepts in Technical Trading Systems.”
The ATR is calculated as the average of the true ranges over a given period. The true range is the greatest of the following: current high less the current low, the absolute value of the current high less the previous close, or the absolute value of the current low less the previous close.
The ATR has a number of uses, including providing traders with stop-loss levels and identifying potential entry and exit points.
Wilder also believed that high ATR readings indicated market tops and low ATR readings indicated market bottoms. However, some traders believe that the ATR is best used as a trailing stop-loss level. As such, they may exit a long position when the ATR falls below a certain level or enter a short position when the ATR rises above a certain level.
How to Calculate ATR – formula
The Average True Range (ATR) indicator measures the price volatility of a financial instrument. It was developed by J. Welles Wilder in his book, “New Concepts in Technical Trading Systems.”
The ATR is not an oscillator, but it can be used to set trailing stop-loss orders.
The ATR has a value ranging from 0 to infinity. The higher the ATR value, the higher the volatility, and vice versa.
The Average True Range formula is very simple:
ATR = MA(TR, n),
where:
TR is the true range,
n is the number of periods used to calculate the ATR.
TR = max[(high – low), abs(high-prevclose), abs(low-prevclose)] .
The ATR calculation includes these steps:
-calculate True Ranges for a given period,
-then calculate an average of those values.
How Average True Range (ATR) Can Improve Your Trading Performance?
Average true ranges (ATRs) are volatility indicators that show how assets move on average over time. The indicator is useful to traders who wish to confirm whether to make a stop-loss order or make an exit order.
Paul Ebersole, Ph.D., recommends using a 14-period ATR for daily charts, a 9-period ATR for weekly charts, and a 6-period ATR for monthly charts.
When applying the ATR indicator to a chart, look for spikes in the indicator which coincide with sharp price movements. These spikes suggest that a period of high volatility has arrived and you should take this into account when setting your stop-loss orders.
Also be on the lookout for periods of low volatility which could precede a period of high volatility. A good way to do this is to compare the ATR values with the price range of candlesticks or bar charts. If the ATR is significantly lower than recent price ranges, this could be an indication that a period of high volatility is about to begin.
How To Read And Use Average True Range
Average True Range (ATR) is a technical analysis indicator that measures the volatility of a stock or other security over time. The ATR is not a measure of price direction but rather measures the degree of price change from day to day.
These indicators can be used as an indicator to identify possible breakouts or as the basis for the definition of trailing stop orders.
The ATR is typically used by traders as a trailing stop-loss order or to exit a trade when the stock or other security reverses direction. While the ATR can be used alone, it is often used in conjunction with other technical indicators to confirm trading signals.
For example, if the ATR is rising while the stock price is falling, this may be indicative of a bottom. Conversely, if the ATR is falling while the stock price is rising, this may be indicative of a top.
As with all technical indicators, it is important to use the ATR in conjunction with other forms of analysis before making any trading decisions.
Example of Using ATR
The ATR is typically used by traders to measure the riskiness of trade and to determine appropriate stop-loss levels.
As such, the ATR can be interpreted as a measure of how much price has moved over a given period of time. The longer the timeframe, the more accurate the ATR will be. However, even on shorter timeframes, the ATR can be useful for identifying stop loss levels and target prices.
For example, suppose a trader buys shares of XYZ stock at $50 and sets a stop-loss at $49.50. Based on the recent ATR, there is a good chance that this stop-loss will be hit if XYZ experiences normal volatility. However, if the ATR is unusually low, it may indicate that XYZ is undervalued and ripe for a breakout. In this case, the trader may consider moving their stop-loss to $48.50 to give the trade some room to breathe.
Ultimately, traders should use the ATR as one tool in their arsenal when making decisions about where to set stop-losses and take profits. By considering both price action and volatility, traders can increase their chances of success in volatile markets.
ATR breakout alerts
A breakout is a move outside of a defined support or resistance area. breakout signals can be used to identify potential buy or sell opportunities.
ATR indicators can be used to identify breakout points. Try monitoring your ATR and looking for a specified period lower value. If there’s any point of interest, try breaking the support level, which may signal a higher volatility or breakout. Tradesmen can use the Average Real Range to determine potential entry and exit points in trade positions.
Remember, periods of volatility will end and you can use them for your benefit. After low volatility, the market expects volatility to grow, which means you may exit your position.
Traders also use ATR values in this way – when the current ATR is above the breakout level, it is a buy signal. When the current ATR is below the breakout level, it is a sell signal.
Trailing Stop Loss by Using ATR
A trailing stop-loss can help exit a trade if asset prices do not move in favor of you. Most day traders use ATRs when they’re searching for trailing stop-loss. Look for ATR values when trading. A common principle is to multiply aTR by two to calculate the appropriate stopping points in your case. If you buy security, the stop-loss could be double the ATR below entry prices. When we short security, we place stops at levels twice the aTR above the entry price to increase our earnings growth rate.
Limitations of ATR
Although ATR can be a useful tool, it is important to be aware of its limitations. First, ATR only measures the recent price action of a security and does not take into account the overall trend or long-term price movements. Second, ATR is a lagging indicator, meaning that it doesn’t predict future price movements, but rather captures how far prices have already moved. Finally, ATR can be subject to false signals in choppy markets. Despite these limitations, ATR can still be a valuable tool for traders, providing them with information about the recent price action of a security and helping to identify potential entry and exit points.
Conclusion
Knowing how to use the Average True Range in your trading can help you set better profit targets and stop losses by giving you a more accurate idea of how volatile security is.
ATR based trading strategies can also help filter out potential false breakouts. If you want to try using an ATR based trading strategy, subscribe to our ATR based trading strategies for free.
