It was introduced by Welles Wilder in his book, “New Concepts in Technical Trading Systems”. ATR is typically used by traders as a measure of market volatility, as well as to identify potential entry and exit points. Because ATR measures the range between the high and low prices of an asset over a given period of time, it is considered to be a good indicator of market volatility. In this article, we will discuss what Average True Range (ATR) is, how it is calculated, and how it can be used by traders.
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What is the Average True Range (ATR)?
The Average True Range (ATR) is a technical indicator that measures the volatility of a security. It was developed by J. Welles Wilder and introduced in his book, New Concepts in Technical Trading Systems.
The ATR is commonly used by traders to measure the risk of a trade before entering into a position. A high ATR indicates a higher degree of volatility, which means that prices are moving more aggressively and there is potential for greater profits or losses. Conversely, a low ATR indicates that prices are relatively stable and there is less potential for large swings.
The ATR is calculated using a simple formula:
ATR = [High(i) - Low(i)]/2- i = the period being analyzed ( typically 14 periods)
- High = the highest price during the period
- Low = the lowest price during the period
How is the Average True Range Calculated?
It was developed by J. Welles Wilder in his book, New Concepts in Technical Trading Systems. The ATR is calculated as the average of the true ranges for a given period. The true range is the greatest of the following:
- The difference between the high and low price of the period
- The absolute value of the difference between the period’s close and the previous period’s high
- The absolute value of the difference between the period’s close and the previous period’s low
The ATR can be used to measure how volatile a stock, commodity, or currency pair is. A higher ATR indicates greater volatility while a lower ATR indicates less volatility.
What are the Benefits of Using the Average True Range?
There are many benefits of using the Average True Range indicator, including its ability to:
- Help traders identify potential market reversals
- Show when security is overbought or oversold
- Help traders set appropriate stop-loss orders
- Give traders an idea of how volatile security is
What are the Drawbacks of Using the Average True Range?
There are a few potential drawbacks to using the Average True Range indicator. First, because it is a lagging indicator, it may not provide timely signals in all market conditions. Second, the ATR can be somewhat volatile, which can make it difficult to interpret. Finally, as with any technical indicator, there is no guarantee that the signals generated by the ATR will be accurate or profitable.
How to Use the Average True Range in Trading?
It is often used by traders to measure the risk of a trade, as well as to determine potential entry and exit points. The ATR is not meant to be used as a standalone indicator, but rather in conjunction with other technical indicators.
When using the ATR to measure the risk of a trade, it is important to consider the time frame that you are trading in. A longer time frame will typically result in a higher ATR, and vice versa. For example, if you are looking at a daily chart, the ATR will be much higher than if you were looking at an hourly chart.
The ATR can also be used to help determine potential entry and exit points. For long trades, you may want to consider entering when the ATR is relatively low and exiting when it starts to increase. For short trades, you may want to enter when the ATR is relatively high and exit when it starts to decrease.
As with any technical indicator, it is important to use the ATR in conjunction with other indicators in order to get a complete picture of what is happening in the market.
Conclusion
The average true range (ATR) is a technical indicator that measures the volatility of a security. It’s typically used by traders to identify potential breakout opportunities or trend reversals. ATR can be applied to any time frame, making it a versatile tool for both short-term and long-term traders. While ATR doesn’t predict price direction, it can be used as part of a broader trading strategy to give you an edge in the market.