How to Master the Average True Range Indicator

Tim Thomas

While the Average True Range (ATR) was originally developed in the 1970s to measure volatility and risk in the commodities market, all trading systems of all asset classes should be focused on risk management. So traders in the forex market, stock, options, commodities or crypto markets should integrate the indicator in their trading strategy.

Tim Thomas

What is the Average True Range?

Unlike other volatility indicators such as Bollinger Bands, the ATR does not give the direction (uptrend or downtrend) or strength of trends. Instead, the indicator only measures how far price typically deviates from the average during a particular time period. When doing technical analysis, it is possible to assess volatility simply by looking at candlesticks. A volatile market will typically show a mix of bullish and bearish candles. The price action during such periods is represented by relatively long wicks (shadows) and short bodies.

Tim Thomas

The average true range is an oscillator whose calculation involves a mathematical formulae. Fortunately, our trading platforms will handle these for us with a couple of clicks. But it is important to understand the ideas behind the calculations and what the indicator is telling us.

Tim Thomas

The ATR Average True Range Formula

The first step is to find what is called the “True Range”, which is simply the largest of three differences in price.  On a daily chart, these would be: – Today’s high minus today’s low – Today’s high minus yesterday’s close – Today’s low minus yesterday’s close

Tim Thomas

The ATR Average True Range Formula

But a true range figure can be derived in a similar way for any time frame.  This will give the amount that the instrument has moved during that time period. The ATR is then calculated as an Exponential Moving Average of the true ranges for a number of time periods. For forex traders and stock traders, this is typically 14.

Tim Thomas

It’s important to understand that it’s a lagging rather than a predictive indicator. It’s perfectly possible for periods of low volatility to coincide with strong trends – and vice versa. The ATR does not provide entry or exit trading signals such as a breakout or reversal. However, as part of a trading strategy, it can be used in conjunction with other technical indicators to ensure optimal risk management.

Tim Thomas

Lagging, not predictive 

Swipe up to get the rest of the article to learn how to use the ATR Indicator for risk management and setting profit targets

Tim Thomas

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