ATR

Average True Range (ATR) is a technical analysis indicator that measures market volatility by decomposing the entire range of an asset price for that period. It was developed by J. Welles Wilder Jr. and is widely used in trading to determine the likely volatility of an asset over the next period.

How It Works

ATR is calculated using a simple moving average of the true range values over a specific period, typically 14 periods. The true range is the greatest of the following:

• The current high less the current low
• The absolute value of the current high less the previous close
• The absolute value of the current low less the previous close

The formula for ATR is:

ATR = [(Previous ATR × (n-1)) + TR] / n

where:

• TR is the true range
• n is the number of periods in the average (usually 14)

Why It Matters for Traders

ATR is a crucial tool for traders for several reasons:

• Stop-Loss Placement: ATR helps in setting appropriate stop-loss orders. A wider ATR indicates higher volatility, so a wider stop-loss is needed to avoid premature exits due to temporary price fluctuations.
• Position Sizing: ATR can help in determining the size of a trade. In higher volatility markets, traders may want to take smaller positions to manage risk.
• Identifying Trends: ATR can help identify trending markets. When the ATR is increasing, it suggests that the market is trending, and when it's decreasing, it suggests a range-bound market.

Example

Consider the EUR/USD pair with a 14-period ATR of 100 pips. If a trader is long on this pair and wants to place a stop-loss order, they might place it 100 pips away from the entry price to account for the expected volatility.

Key Takeaways

• ATR measures market volatility by decomposing the entire range of an asset price for that period.
• ATR is calculated using a simple moving average of the true range values over a specific period.
• ATR is used for stop-loss placement, position sizing, and identifying trends.