The Average True Range (ATR) is a key technical indicator used to measure market volatility. Developed by J. Welles Wilder Jr., it helps traders understand how much an asset typically moves within a given period. Here’s a detailed breakdown of its calculation and practical applications.
What Is the Average True Range (ATR)?
The ATR reflects the average volatility of an asset over a specified timeframe.
- High ATR = Significant price fluctuations (high volatility).
- Low ATR = Stable price movements (low volatility).
ATR is particularly useful for:
- Setting trailing stop-loss orders.
- Adjusting position sizes based on volatility.
Step-by-Step Calculation of ATR
1. Determine the True Range (TR)
The True Range accounts for price gaps (e.g., overnight jumps) and is the largest of:
- Today’s high − Today’s low
- |Today’s high − Yesterday’s close| (absolute value)
- |Today’s low − Yesterday’s close|
Example:
- Today’s high: $50 | Today’s low: $48 | Yesterday’s close: $49
- TR = max($50 − $48, |$50 − $49|, |$48 − $49|) = $2
2. Calculate the ATR
The ATR is the moving average of the TR over a chosen period (commonly 14 days). For the first ATR value, use a simple average of the initial TRs.
Formula:
- First ATR = Average of TRs over n days.
- Subsequent ATRs = [(Prior ATR × (n−1)) + Current TR] / n
Example (22-day ATR):
- Prior ATR: 0.9332 | Current TR: 0.68
- ATR = [(0.9332 × 21) + 0.68] / 22 = 0.9215
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Practical Uses of ATR
1. Trailing Stop-Loss with Chandelier Exit
A popular method uses:
- Lookback period: 22 days.
- Multiplier: 3× ATR.
Formula:
Trailing Stop = Highest High (22-day) − (3 × ATR)
Example:
- Highest High (22-day): $75 | ATR: 0.9215
- Trailing Stop = $75 − (3 × 0.9215) = $72.24
2. Position Sizing
Adjust trade sizes based on volatility:
- Higher ATR → Smaller position to manage risk.
- Lower ATR → Larger position for stable assets.
FAQs About ATR
Q: What’s the best period for ATR?
A: 14 days is standard, but adjust based on strategy (e.g., 22 days for swing trading).
Q: Can ATR predict price direction?
A: No—it only measures volatility, not trend direction.
Q: How does ATR compare to Bollinger Bands?
A: Bollinger Bands incorporate standard deviation, while ATR focuses purely on price range.
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Key Takeaways
- ATR quantifies volatility, not trend.
- Use it for stop-loss placement and risk management.
- Customize the period and multiplier to fit your trading style.
By integrating ATR into your strategy, you can make more informed decisions and better manage market risks.
Disclaimer: Trading involves risks. Past performance doesn’t guarantee future results.