Average True Range (ATR)

Intermediate
March 27, 2023
Read time:
5m

The Average True Range (ATR) is a technical analysis indicator to measure the market’s volatility. It calculates the average market volatility over a specific period by considering price range values and price changes.


ATR can serve various purposes, including trend analysis and determining stop losses. A higher ATR signifies increased market volatility, which translates to greater risk and offers more possibilities for higher returns.


When utilizing ATR as a stop-loss indicator, the stop-loss is established at particular points above or below the current market price. This accounts for market volatility and minimizes the risk of loss.


If the ATR value rises, this indicates an increase in market volatility, potentially signifying a sustainable trend. Conversely, a decline in ATR’s value may imply a decrease in market volatility, suggesting a weakening trend or a correction phase.


The Average True Range can be calculated for different periods based on specific needs and trading strategies. More extended periods result in more days being considered when calculating its value, leading to smoother ATR outcomes.


To calculate the ATR, follow these steps:

1. Determine the True Range (TR) value for each trading day. The True Range is the highest value of the three following calculations:

a) The difference between the highest and lowest price of a given day,

b) The difference between the closing price of a given day and the highest price of the previous day,

c) The difference between the closing price of a given day and the lowest price of the previous day,

2. Compute the average TR value for a certain number of days (typically 14).

The formula to calculate ATR (with a previous ATR) is as follows:
PreviousATR (n – 1) + TR

where:
n – number of periods
TR – True Range

The ATR might be more sensitive to short-term market volatility, when analyzing shorter periods. In contrast, a longer period ATR may provide a smoother result, making it more suitable for analyzing long-term market volatility.

Summary

The Average True Range (ATR) is a technical analysis indicator used to measure the volatility of price movements over a given period. It calculates the average value of an asset's volatility range by considering minimum and maximum price levels and difference between the current and closing prices of the previous sessions.


Investors commonly use the ATR to set stop-loss levels and determine the optimal position, based on the analyzed instrument's volatility.

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