What is Average True Range ATR: Definition & Meaning Explained

by Felix Dunogent

Day traders use the daily ATR to measure how much an asset moves during the day. The line on an intraday chart, such as a one-minute or five-minute chart, will spike at times of heightened volatility. For example, there tends to be more trading activity during the overlap between the London and New York sessions.

• A mistake traders make in how to use ATR is to assume that volatility and trend go in the same direction.
• If they move in the same direction and the ATR line breaks its moving average on the smaller time frame, it means that the market becomes animated.
• Stop losses are market orders that would exit a losing trade at a predetermined price.
• Trading signals occur relatively infrequently but usually indicate significant breakout points.
• American Express (AXP) broke its down trending trendline with a gap up opening on Oct. 20, 2016 creating a potential buy signal (see “Buying range,” below).
• It is usually used to analyze the risk of taking a specific position in the market.

Suppose that the trading range for a stock is 1.40, and the stock’s moved up 40% above the average. The indicator is calculated on the basis of the so-called true ranges. It uses the absolute value of the current high less the previous close or the absolute value of the current low less the previous close. For the table below, the figures have been used to calculate a 14-day ATR over a 10-day period.

What Is Average True Range?

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. The first step in calculating ATR is to find a series of true range values for a security. The price range of an asset for a given trading day is its high minus its low. To find an asset’s true range value, you first determine the three terms from the formula. The Average True Range (ATR) measures the conventional range of a bar but checks the previous bar’s closing price to see if it is outside the current bar’s range.

It is usually used to analyze the risk of taking a specific position in the market. One way of doing this is to predict daily movements based on historic values of ATR, and to enter or exit the market accordingly. It is often used as a way to calculate stop-loss and profit targets. For example, a daily stop-loss may be set at 1.5X or 2X the ATR.

How to Calculate the ATR

A sharp decline or rise results in high Average True Range values. Typically, the Average True Range (ATR) is based on 14 periods and can be calculated on an intraday, daily, weekly or monthly basis. Because there must be a beginning, the first TR value is simply the High minus the Low, and the first 14-day ATR is the average of the daily TR values for the last 14 days. After that, Wilder sought to smooth the data by incorporating the previous period’s ATR value. A trailing stop-loss is a way to exit a trade if the asset price moves against you but also enables you to move the exit point if the price is moving in your favor. Many day traders use the ATR to figure out where to put their trailing stop-loss.

Average true range does not indicate the direction of the market, but simply the volatility (see “Measuring volatility,” below). The equation gives the most recent price movement greater significance; hence, it is used to measure market sentiment. An asset’s range is the difference between the high and low prices during a specified time period.

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All these readings are plotted on a graph to form a continuous line, so traders can see how volatility has changed over time. The ATR indicator is a non-directional indicator, which means that it does not provide any insight into the currency pair’s market
movement or potential price movement. This results in mixed signals, especially when the markets are highly volatile and when
trends are about to end.

A day trader can use this in combination with other indicators and strategies to plan trade entry and exit points. Having a picture of the volatility can help traders to set definitive price targets in the market. For instance, if the EURUSD currency pair has an ATR of 100 pips over the last 14-time periods, a price target of below 100 pips is more likely to be achieved within the prevailing trading session.

Eight months is a particularly long time frame to use for ATR, but it illustrates how the indicator tracks volatility clearly for the purpose of this example. CFTC Rule 4.41 – Hypothetical or Simulated performance results have certain limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, because the trades have not actually been executed, the results may have under-or-over compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs, in general, are also subject to the fact that they are designed with the benefit of hindsight.

AlertLength( 14 ) sets the number of recent bars used to determine an extreme value of the average true range. When the market is volatile, one should set wider stops in order to avoid being stopped out of the trading by some random market noise. A break to the upside signals that the price action has become more intense. The default ‘n’ on most trading platforms is 14, but traders can adjust the number according to their needs.

This gives an asset price freedom to vary naturally during a trading day, but still sets a reasonable exit position. Depending on a trader’s timeframe, a move beyond current ATR levels would indicate a change in market trend. For example, when analysing a price chart, traders often use the ATR to determine where to place a trailing stop loss. You can multiply the current ATR reading by two and place the stop loss at this level.

• ATR was originally developed for the commodities market, but it can also be applied to forex, stocks and indices.
• A high ATR is typically generated by a sharp advance (1) or decline in price.
• In summary, the Average True Range is a valuable technical indicator for measuring market volatility and managing risk.
• Typically, the ATR calculation is based on 14 periods, which can be intraday, daily, weekly, or monthly.
• While fixed price levels or percentages don’t allow for volatility, a trailing stop based on the ATR will adapt to sharp changes.
• You would repeat this throughout a specific time frame to achieve a moving average of a series of true ranges.

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