What is 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, this measures market volatility by breaking down the entire range of an asset price for that time period.
The true range indicator is considered to be the greater of the following: current high minus current low; the absolute value the current high minus the previous close; and the absolute value of the current low minus the previous close. The ATR is then a moving averagetypically using 14 days, actual ranges.
Key points to remember
- The Average True Range (ATR) is a market volatility indicator used in technical analysis.
- It is usually derived from the simple 14 day moving average of a series of real range indicators.
- The ATR was originally developed for use in commodity markets, but has since been applied to all types of securities.
Volatility Calculation with Average True Range
The Average True Range (ATR) formula
The first step in calculating ATR is to find a series of true range values for a security. An asset’s price range for a given trading day is simply its high minus its low. Meanwhile, the true range is more encompassing and is defined as follows:
JR=Max[(H − L),Abs(H − CP),Abs(L − CP)]AJR=(not1)(I=1)∑(not)JRIwhere:JRI=A real special rangenot=The period used
How to Calculate Average True Range (ATR)
Traders can use periods shorter than 14 days to generate more trading signalswhile longer timeframes have a higher probability of generating fewer trading signals.
For example, suppose a short term Trader only want to analyze volatility of one share over a period of five trading days. Therefore, the trader could calculate the five-day ATR. Assuming historical price data is arranged in reverse chronological order, the trader finds the maximum of the absolute value of the current high minus the current low, the absolute value of the current high minus the previous close, and the value absolute from the current low. less the previous close. These true range calculations are performed for the most recent five trading days and are then averaged to calculate the first five-day ATR value.
What does the Average True Range (ATR) tell you?
Wilder originally developed the ATR to goodsalthough the indicator can also be used for stocks and indices.Simply put, a stock with a high level of volatility has a higher ATR, and a stock with low volatility has a lower ATR.
The ATR can be used by market technicians for entering and exiting 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 using simple calculations. The indicator does not show the price direction; rather, it is used primarily to measure volatility caused by deviations and limit upward or downward movements. The ATR is quite simple to calculate and only requires historical price data.
ATR is commonly used as an exit method that can be applied regardless of how the entry decision is made. A popular technique is known as “chandelier exit” and was developed by Chuck LeBeau. The exit of the chandelier places a trailing stop below the highest level the stock has reached since you entered the trade. The distance between the highest level and the stop level is defined as several times the ATR. For example, we can subtract three times the value of the ATR from the high since we entered the trade.
The ATR can also give a trader an indication of the size of the trade to put in place. derivatives markets. It is possible to use the ATR approach to position size which takes into account an individual trader’s willingness to accept risk as well as the volatility of the underlying market.
Example of using the Average True Range (ATR)
As a hypothetical example, suppose the first five-day ATR value is calculated as 1.41 and the sixth day has an actual range of 1.09. The sequential ATR value can be estimated by multiplying the previous ATR value by the number of days minus one and then adding the actual range for the current period to the product.
Then divide the sum by the selected period. 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.
Although the ATR does not tell us in which direction the breakout will occur, it can be added to the the last price, and the trader can buy whenever the next day’s price trades above this value. This idea is illustrated below. Trading signals occur relatively infrequently, but usually spot significant breakout points. The logic behind these signals is that each time a price closes more than one ATR above the most recent close, a change in volatility has occurred. Take a a long position bets the stock will follow higher.
Limits of Average True Range (ATR)
There are two main limitations to using the ATR indicator. The first is that the ATR is a subjective measurement, which means it is subject to interpretation. There is no single ATR value that will tell you for sure that a trend is about to reverse or not. Instead, ATR readings should always be compared to previous readings to get an idea of how strong or weak a trend is.
Second, the ATR only measures volatility and not the direction of an asset’s price. This can sometimes result in mixed signals, especially when markets are experiencing pivots or when trends are at turning points. For example, a sudden increase in the ATR following a large move against the prevailing trend may lead some traders to believe that the ATR is confirming the old trend; however, this may not be the case.