The Average True Range (ATR) is a technical indicator that is used to measure the volatility of a security. It was developed by J. Welles Wilder Jr. and is commonly used in conjunction with other indicators to help traders determine appropriate stop-loss and take-profit levels.
The ATR is calculated as the average of the true range over a specified number of periods. True range is the greatest of the following three values:
• The difference between the current high and the current low
• The difference between the current high and the previous close
• The difference between the current low and the previous close
The resulting value is the average true range, which is usually displayed as a single line on a chart, oscillating around a central level.
Formula for ATR
The formula for Average True Range (ATR) is:
TR = MAX(MAX(HIGH-LOW, ABS(HIGH-REF(CLOSE,1))), ABS(LOW-REF(CLOSE,1)))
ATR = SMA(TR, n)
Where:
TR = True Range
HIGH = Current day's highest price
LOW = Current day's lowest price
CLOSE = Previous day's closing price
REF(CLOSE,1) = Previous day's closing price
ABS = Absolute value function
SMA = Simple Moving Average
n = Number of periods (usually 14 is used)
The ATR can be used in several ways to generate trading signals. One of the most common ways is to use the ATR to set stop-loss and take-profit levels. A trader might use the ATR to set a stop-loss level that is a certain multiple of the ATR value away from the current price. Similarly, a trader might use the ATR to set a take-profit level that is a certain multiple of the ATR value away from the current price.
Another way to use the ATR is to look for divergences between the ATR and price action. When the ATR is making new highs while price is failing to do so, it can be a bearish divergence and a warning of a potential trend reversal. Similarly, when the ATR is making new lows while price is failing to do so, it can be a bullish divergence and a warning of a potential trend reversal.
It's important to note that the ATR is a volatility indicator and it's a lagging indicator, which means that it is based on past price data and may not always provide accurate predictions about future price movements. As with any indicator, it is best to use the ATR in conjunction with other indicators and analysis techniques to confirm signals and get a better understanding of the market conditions.
Keep in mind that the ATR is used to measure the volatility of a security, and it's important to use it in conjunction with other indicators and analysis techniques to get a better understanding of the market conditions.
Usage
The Average True Range (ATR) is a useful technical indicator to measure volatility and assist with setting stop-loss levels. It can be used in any market and time frame to help traders and investors identify the potential level of price movements.
ATR is particularly useful for those who employ trend-following strategies or those who want to incorporate volatility into their trading decisions. ATR can help traders set stop-loss levels and adjust their position sizes to reflect the current market conditions.
However, ATR may not be as useful for those who employ short-term, high-frequency trading strategies as it is designed to measure longer-term price movements. Additionally, traders should be aware that ATR is a lagging indicator and may not provide timely signals for fast-moving markets.
Overall, ATR can be a valuable tool for traders and investors when used appropriately in combination with other technical indicators and fundamental analysis.