ATR: Average True Range

The Volatility Indicator can help you to determine market volatility and enhance your trading strategy.

Thu Aug 17, 2023

But What is the Average True Range?

Average True Range (ATR) is introduced by market technician J. Welles Wilder Jr. It measures market volatility by calculating the average range between high and low prices over a specified period. What sets ATR apart is its ability to consider price gaps, providing you with a more accurate representation of actual price movement.

Before we understand ATR, it is important to learn about its building blocks: Range and True Range.

Range: It is the difference between the High and Low of a (Candle) stock over a specific period.

True Range (TR): It is a modified version of Range and takes into account gaps in the price. True Range is calculated by measuring the maximum value between the previous candle’s Close and the current Candle’s High or Low.

Average True Range (ATR): It is a smoother version of True Range. It's calculated by averaging the True Range values over a specified number of periods. 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

Interpreting Average True Range (ATR):

Interpreting the ATR is simple. If you look at the following image, you can observe that ATR had been rising from 1st August to 7th August, At the same time Price had been falling. And when ATR was falling, the price become sideways or little rising.

Hope you already know that Price behavior is indirectly proportional to Volatility. Volatility increase means, more & more traders/investors are participating in the Market. But when too many people participated, when there is a Panic Situation. So, always remember, when Volatility increase there is more chance to Fall the Market

The Average True Range (ATR) Formula:

The formula to calculate ATR for an investment with a previous ATR calculation is :

$\begin{matrix} \frac{Previous ATR (n - 1) + TR}{n} \\ where: \\ n = Number of periods \\ TR = True range \end{matrix}$

How to use Average True Range (ATR)?

Average True Range (ATR) measures volatility and can be used for-

Volatility Assessment: Understand whether a market is experiencing high or low volatility. ATR values give you a clear picture of potential price swings, helping you adapt your strategy accordingly.
Risk Management Optimization: ATR empowers you to set appropriate stop-loss and take-profit levels. By accounting for volatility, you can set Stop Loss and Target Profit that align with the market's normal fluctuations.
Position Sizing: ATR helps you manage risk effectively by considering the market's true volatility, ensuring your position sizes match the level of risk you're comfortable with.

How Do You Use ATR Indicator in Trading?

The Average True Range is used to evaluate an investment's price volatility. It is used in conjunction with other indicators and tools to enter and exit trades or decide whether to purchase an asset.

Conclusion

The average true range is an indicator of the price volatility of an asset. It is best used to determine how much an investment's price has been moving in the period being evaluated rather than an indication of a trend. Calculating an investment's ATR is relatively straightforward, only requiring you to use price data for the period you're investigating.

Happy Trading & Investing!

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Option Trader Nitesh
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Disclaimer: The above article is based on my personal knowledge & experiences. I am not a SEBI Registered Analyst. I never provide any Tips, Paid Calls, Recommendations, Assurance, Guaranteed Services, etc. I only charge for my Mentorship Program. Please consult with your Financial Advisor before doing anything in Stock Market. I am not liable for any Profit or Losses