Average True Range (ATR)

1. What is the Average True Range?
2. How is the Average True Range calculated?
3. Trading with the Average True Range
4. Overview of the Average True Range

The Average True Range (ATR) indicator is popular among technical traders as a tool for quickly assessing market volatility. Let's take a look at how it works.

What is the Average True Range?

The Average True Range (ATR) is a technical tool displayed as a single line beneath the market chart. When this line rises, it indicates that the market is experiencing higher volatility. Conversely, when it falls, volatility decreases.

Standard ATR setting is 14, so it calculates the average true range over the last 14 periods. This average value is displayed as a dashed line.

ATR was originally designed for commodity markets, but today traders use it across various markets and asset classes.

How is the Average True Range calculated?

When calculating the Average True Range (ATR), three key values are used:

1. The difference between the current high and the low of the market.

2. The difference between the current high and the previous close.

3. The difference between the current low and the previous close.

The largest of these three values represents the true range.

Example: For USD/JPY, we have the following values:

• Current high: 113.73

• Current low: 113.32

• Previous close: 113.98

Now, we calculate the three values:

• 113.73 - 113.32 = 0.41

• 113.73 - 113.98 = -0.25

• 113.32 - 113.98 = -0.73

The largest value is 0.73, which represents the true range for the given period.

It doesn’t matter that one of the numbers is negative – ATR considers the highest absolute value.
By default, the ATR indicator calculates the true range over the last 14 periods, then converts this range into a moving average. This average is represented as a line on the chart.

As with other indicators, you can adjust the ATR to include any number of periods, depending on your preference. Short-term traders often use ATR with 10 or fewer periods.

Trading with the Average True Range

As a volatility indicator, ATR is commonly used to evaluate trading opportunities – particularly in determining whether to trade and where to place stop-loss and take-profit orders.

ATR and market movements

ATR gives you a quick insight into how the market typically moves within a given period. This information is useful when deciding whether to act on a signal provided by another indicator.
For example, if ATR shows the market usually moves by 20 points during a session and you spot a sell opportunity, but the market has already dropped by 25 points, it may be wise to reconsider the trade.

Stops and limits with ATR

ATR is also helpful in determining suitable levels for profit targets and stop-loss orders. If the market moves by 20 points a day, targeting 50 points in the current session may be unrealistic.

This indicator also assists in placing stop-loss orders. If the market is more volatile than usual, you may need to set the stop-loss further from the current price to avoid premature trade closure. However, keep in mind that this will increase the overall risk of the trade.

Overview of the Average True Range