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Average True Range (ATR), What It Means, and How to Use It

29 January 2023, 22:44

Sergey Batudayev

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What Is the Average True Range (ATR)?

The average true range (ATR) is a technical analysis indicator introduced by market technician J. Welles Wilder Jr. in his book New Concepts in Technical Trading Systems that measures market volatility by decomposing the entire range of an asset price for that period.1

The true range indicator is taken as the greatest of the following: current high less the current low; the absolute value of the current high less the previous close; and the absolute value of the current low less the previous close. The ATR is then a moving average, generally using 14 days, of the true ranges.

Traders can use shorter periods than 14 days to generate more trading signals, while longer periods have a higher probability to generate fewer trading signals.

KEY TAKEAWAYS

The average true range (ATR) is a market volatility indicator used in technical analysis.
It is typically derived from the 14-day simple moving average of a series of true range indicators.
The ATR was initially developed for use in commodities markets but has since been applied to all types of securities.
ATR shows investors the average range prices swing for an investment over a specified period.

What Does the ATR Tell You?

Wilder originally developed the ATR for commodities, although the indicator can also be used for stocks and indices.1 Simply put, a stock experiencing a high level of volatility has a higher ATR, and a lower ATR indicates lower volatility for the period evaluated.

The ATR may be used by market technicians to enter and exit trades and is a useful tool to add to a trading system. It was created to allow traders to more accurately measure the daily volatility of an asset by using simple calculations. The indicator does not indicate the price direction; instead, it is used primarily to measure volatility caused by gaps and limit up or down moves. The ATR is relatively simple to calculate, and only needs historical price data.

The ATR is commonly used as an exit method that can be applied no matter how the entry decision is made. One popular technique is known as the "chandelier exit" and was developed by Chuck LeBeau. The chandelier exit places a trailing stop under the highest high the stock has reached since you entered the trade. The distance between the highest high and the stop level is defined as some multiple multiplied by the ATR.

Example of How to Use the ATR

As a hypothetical example, assume the first value of a five-day ATR is calculated at 1.41, and the sixth day has a true range of 1.09. The sequential ATR value could be estimated by multiplying the previous value of the ATR by the number of days less one and then adding the true range for the current period to the product.

Next, divide the sum by the selected timeframe. For example, the second value of the ATR is estimated to be 1.35, or (1.41 * (5 - 1) + (1.09)) / 5. The formula could then be repeated over the entire period.

While the ATR doesn't tell us in which direction the breakout will occur, it can be added to the closing price, and the trader can buy whenever the next day's price trades above that value. This idea is shown below. Trading signals occur relatively infrequently but usually indicate significant breakout points. The logic behind these signals is that whenever a price closes more than an ATR above the most recent close, a change in volatility has occurred.

How do I use the ATR in my trading

In my trading, I use ATP as an indicator showing the power reserve of the instrument, that is, when I see an entry into the market, I also check the presence of energy in the instrument at a given time until reaching my take profit. The standard ATR is a little difficult to quickly determine the situation in the market and is not entirely informative. So I created my own indicator based on ATR and now I will explain how and why it is useful to me.

I named my indicator Power reserve, that indi allows to understand how much "fuel is still left with the tool." Imagine the situation, you drove off in a car with a half-discharged battery, on average, usually this amount of energy is enough for a car for 250 km, respectively, with all your desire, you cannot overcome a path of 700 km. So for each instrument, there is a certain daily price movement, and as a result of statistical observations, it was revealed that 95% of the time the asset passes 1 ATR per day, and only 5% of the time 2 or more ATR.

Example, daily ATR EURUSD = 682 pips. You enter a trade, let's say, at a breakdown of the level with a TP of 500 pips, it would seem that you set the correct TP size, but you did not take into account that the asset had already passed 90% of its daily ATR by the time the trade was opened, and accordingly, the instrument most likely does not have enough energy to receive you TP, if you saw that the instrument had only 10% charge left, you would most likely either adjust the TP, or not enter the trade at all.

The Power Reserve indicator calculates how much in % and in points the instrument has used up inertia and how much it still has left.

Power Reserve MT5

The indicator itself is made in the form of a battery indicator, which we are used to seeing in electronic devices.

Using this indicator, you immediately understand:

- daily price movement (the screenshot shows Bitcoin's daily ATP, so don't be afraid of such large numbers)
- your possible TP size
- as a percentage, it is indicated how much % of the stock moves the instrument has left for today, below you see the same indicator but in points

Here is an example on GBPUSD

Agree that, compared to a standard indicator, mine makes it immediately clear what's what and how to use it. I hope this information will be useful to you, put likes and write your comments. I hugged everyone, good profit to all!