20 October 2024
Average True Range (ATR) Formula, What It Means, and How to Use It.
What Is the Average True Range (ATR)?
The Average True Range (ATR) is a technical indicator used in financial markets to measure the volatility or price fluctuation of an asset over a specific period. It was developed by J. Welles Wilder and introduced in his book “New Concepts in Technical Trading Systems” in 1978.
The ATR provides traders and investors with a way to quantify the degree of price movement in an asset, which can be valuable for various purposes, including risk management and trade strategy development.
KEY TAKEAWAYS
- Volatility Measurement: The primary purpose of the ATR is to quantify the volatility of an asset. It does so by considering the range between the daily high and low prices, as well as any price gaps.
- True Range Calculation: To calculate the ATR, you first calculate the True Range (TR) for each day in the chosen period. The True Range is the greatest of the following three values:
- High – Low
- Absolute value of (High – Previous Close)
- Absolute value of (Low – Previous Close)
- Smoothing Over Time: Once you have the True Range values, the ATR is calculated by taking an average of these values over a specified period (commonly 14 days but can be adjusted). This smoothing helps create a more stable representation of price volatility.
- Interpreting ATR: A higher ATR value indicates greater price volatility, suggesting that the asset’s price is making larger price swings. Conversely, a lower ATR value indicates lower volatility, implying that the asset’s price movements have been relatively stable.
- Applications: Traders and investors use the ATR for several purposes, including setting stop-loss levels, determining position size, assessing risk, and confirming trends. For example, a trader might set a wider stop-loss in a high-volatility market to account for larger price fluctuations.
ATR MEANING
Average True Range (ATR) meaning in english, hindi, urdu, tamil, marathi, canada:
- English: Average True Range (ATR).
- Hindi: औसत सच्ची रेंज (एटीआर).
- Urdu: معمولی حقیقی رینج (ATR).
- Tamil: சரியான இரட்டை வரை (ATR).
- Marathi: सरासरी सचेत आरेंज (एटीआर).
- Canadian French: Moyenne Vraie Portée (MVP).
The Average True Range (ATR) Formula
The ATR is calculated using the following formula:
ATR = [(Previous ATR) x (n-1) + True Range] / n
Where:
- Previous ATR: The ATR value from the previous period (usually the previous day or the previous trading session).
- n: The period or the number of days used for the calculation. Common values for n range from 14 to 21, but you can adjust it to your preferences.
How to Calculate the ATR
How to Calculate the ATR:
- Choose an initial period (n), typically 14 days.
- Calculate the True Range (TR) for each day in the chosen period. The True Range is the greatest of the following three values:
- High – Low
- Absolute value of (High – Previous Close)
- Absolute value of (Low – Previous Close)
- Sum up the True Range values for the selected period.
- Calculate the ATR using the formula mentioned above.
What Does the ATR Tell You?
The ATR provides information about the volatility of an asset’s price over a specific period.
Here’s what it can tell you:
- Volatility: A higher ATR value indicates higher price volatility, while a lower ATR value suggests lower volatility. This information is essential for traders and investors to assess risk and adjust their trading strategies accordingly.
- Setting Stop-Loss Levels: Traders often use the ATR to set stop-loss levels. A larger ATR might warrant a wider stop-loss to account for higher price fluctuations, while a smaller ATR may lead to a tighter stop-loss.
- Position Sizing: ATR can also be used to determine the size of a position. In more volatile markets, traders might reduce their position size to manage risk effectively.
Example of How to Use the ATR
Example of How to Use the ATR: Suppose you’re trading a stock with a 14-day ATR of $2. If you want to set a stop-loss level that accommodates normal price fluctuations, you might choose to set it $2 below your entry price.
Limitations of the ATR
Limitations of the ATR:
- Lagging Indicator: Like many technical indicators, the ATR is a lagging indicator, which means it provides information about past price volatility. It may not always accurately predict future volatility.
- Doesn’t Indicate Direction: ATR tells you about volatility but doesn’t indicate the direction of price movement. Traders need to use it in conjunction with other indicators to make informed decisions.
- Dependent on Period Choice: The ATR value can vary based on the chosen period (n). Different periods can provide different insights into an asset’s volatility, and there’s no one-size-fits-all setting.
- Not Suitable for All Assets: ATR may not be as useful for assets with low liquidity or erratic price movements, as it relies on price ranges to calculate volatility.
Average True Range FAQ
What is the best average true range setting?
The best average true range (ATR) setting depends on the specific market or security you are analyzing and your trading strategy. Generally, a common setting for ATR is 14 periods, which is the default setting on many charting platforms. However, you may need to adjust the setting based on the time frame you are trading and the volatility of the market or security.
How do you read an ATR indicator?
To read an ATR indicator, you need to understand its basic concept. ATR measures the average range between the high and low prices over a specified period. It provides an indication of the volatility or price movement of a market or security. A higher ATR value suggests greater volatility, while a lower value indicates lower volatility.
How do you use ATR for stop loss?
When using ATR for stop loss placement, you can set your stop loss level based on a multiple of the ATR value. For example, you may choose to set your stop loss at 2 times the ATR value below your entry price. This technique allows for some flexibility in adjusting the stop loss based on market volatility. By using ATR, you can potentially avoid placing your stop loss too close to the current price, which could result in premature stop-outs during normal market fluctuations.
The Bottom Line
The Average True Range (ATR) is a valuable tool for assessing and quantifying price volatility in financial markets. It helps traders and investors make informed decisions by providing a numerical measure of the asset’s recent price fluctuations. By understanding the ATR, market participants can adapt their trading strategies and risk management techniques to suit prevailing market conditions.