ATR Trading involves using the ATR as a key trading tool to help traders make informed decisions.
In this article, we will explore what the ATR indicator is. Also, how you can use ATR in stock market and the benefits of incorporating it into your ATR trading strategy.
What is ATR?
ATR stands for Average True Range and is a way to measure how much a stock or currency is moving. It provides traders with a gauge of how much an asset moves in value over a specific time frame.
The ATR calculation takes into account any gaps in price movement that may occur during the trading day. And it gives traders a more comprehensive view of an asset’s price movement.
To calculate ATR, you take the average of the stock’s price changes over a certain period of time. This helps traders make better decisions about when to buy or sell a stock and how much of it they should buy or sell. ATR gives traders a good idea of how much risk there is in a trade. So, traders can set appropriate stop-loss levels.
The Average True Range (ATR) Formula
The formula for Average True Range (ATR) is calculated as follows:
- True Range (TR) = max(current high – current low, absolute value of current high – previous close, absolute value of current low – previous close)
- Average True Range (ATR) = average of TR over a set number of periods (typically 14 periods)
- the current high is the highest price of an asset on a given day
- current low is the lowest price of an asset on a given day
- the previous close is the closing price of an asset from the previous day
- the set number of periods is typically 14, but it can be adjusted to suit the trader’s preference
The result is a single value that represents the average range of price movements over a set number of periods.
How to Calculate the ATR
Calculating the Average True Range (ATR) involves these steps:
- Find the “true range,” which is the greatest of the current high minus the current low, the absolute value of the current high minus the previous close, and the absolute value of the current low minus the previous close.
- Average the true range over a set number of periods, usually 14.
- Divide the sum of the true ranges by the number of periods to get the ATR.
- Repeat the calculation for each period to get a series of ATR values.
ATR values show the asset’s volatility in the same units as the asset being traded.
What Does the ATR Tell?
Basically, the Average True Range indicator tells us about the trend change in the market and reveals the volatility of different assets.
An increasing ATR represents higher volatility in the market as the spread between bars widens. A reversal in price with an increase in ATR would imply the strength behind that move. Given that ATR is non-directional, an increasing ATR could be indicative of either growing selling or buying pressure.
If the ATR is low, it means the ranges have been relatively narrow throughout a string of periods. A low average value indicates that prices are less likely to fluctuate. Consistently low ATR readings may point to a period of consolidation before the next possible reversal or continuance.
The ATR (Average True Range) indicator helps traders determine when to enter or exit a trade by adjusting to changes in price volatility. Moreover, we can also use it as ATR trailing stop indicator to calculate a stop loss level and minimize losses.
Example of How to Use the ATR
For example, if the ATR on a 1-minute chart is 0.05, for instance, that means the price is fluctuating by about 5 cents during that time frame. If you think the price will rise and decide to buy, you should know that it will probably take at least five minutes for the price to rise by 15 cents.