ATR - Average True Range. A Volatility Indicator

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Introduction

The ATR tells us the average trading range of the market for X amount of time, where X is whatever you want it to be. This Indicator was developed by Wilder as a volatility indicator, reflecting the interest (strength) or otherwise in a market at a particular price. The ATR can be used to validate the enthusiasm behind a move or breakout - much in the same way Volume can.  A bullish reversal with an increase in ATR would show strong buying pressure and reinforce the reversal. A bearish support break with an increase in ATR would show strong selling pressure and reinforce the support break.

We'll also explore using The ATR to help set stop/loss positions.  Having an idea of how much the market is likely to move in the day-to-day noise of the market is always a good idea. This along with other factors already discussed in previous modules can be used to set stop loss positions.  Another use of The ATR is to help Day Traders setting their profit targets.  If you want to exit a trade before the day's end there's no point setting your profit target 2 x the current ATR.

Charting ATR

ATR is based on the True Range over a period of time, which uses absolute price changes. As such, ATR reflects volatility at an absolute level. This means low priced stocks will have lower ATR values than high price stocks - A €/$/£10 security will have a much lower ATR values than a  €/$/£100 security. Because of this, ATR values are not comparable.

For the calculation of ATR, look at this Wikipedia page: https://en.wikipedia.org/wiki/Average_true_range

In the chart below we can see the ATR situated just under the market's price - The default is usually 14-periods.  High values indicate enthusiasm for the market and high price volatility and low values indicate low volatility. Notice how The ATR rises as the trend develops.  There is increased interest in USD/JPY as the price trends up.

USD/JPY - Average True Range

Trading the Break-out with ATR

For Clarity, we're going to talk about trading the break-out of a range, channel or support & resistance here.  NOT The ATR Break-Out, which is a day trading strategy where price breaks above or below the current ATR to form trading signals

The ATR proves to be a very useful indicator.  One of the main uses you'll find is while trading the break-out, one version of which is the directional/non directional bias straddle trade.  At resistance, an increase in ATR show's strong buying pressure and can reinforce a break. A bearish support break with an increase in ATR would show strong selling pressure and reinforce the support break.  This can be especially useful in the Forex market, as the FX market doesn't have a volume indicator as such (although traders use The COT report), so measuring volatility is the next best thing.

Let's look at an example using EUR/CAD where we can use the ATR to determine the health of the break-out.  Over the period of several months the ATR of EUR/CAD has contracted to record lows.  Often, after a period of consolidation the ATR get's lower (As Volume does, indicating waning market demand) and we can see this in the below chart.

EUR/CAD - ATR confirming Break-Out

After marking the low of the ATR and it's high as price breaks through support or resistance (in this case resistance), we can measure the change in volatility.  Any increase in volatility over 10% suggests that there's a lot of capital entering the market at these prices. In this case the increase is 11.36%, which can help confirm the break-out.  In some cases a further confirmation can occur when price re-tests previous support or resistance. 

Entry to this trade may be after 1 full candle moves above or below resistance or support, or you may want to wait for further confirmation, like a re-test of previous resistance or support.  A stop/loss will probably be placed under previous resistance in this case - Money management rules always apply...

Using ATR to Set Stop/Loss

There are many ways to determine stop loss positions.  As we've learned in previous modules some stop loss positions can be set under the last periods open (or over the last periods open if going short), under moving averagestrend linessupport and resistance levels and by using Parabolic SAR.  We can also set stop/loss positions with The ATR and we'll explore this below.

Setting Stops using Volatility Using Average True Range to Set Stop Losses

Having an idea of how much the market is likely to move in the day-to-day noise of the market is always a good idea.  This along with other factors already discussed in previous modules can be used to set stop loss positions. If you are trading a stock that moves €/$/£ 2 a day, or a stock that trades €/$/£ 1 a day, your stop loss may be wider on the former.  But how can you determine the volatility of a market.  We use the Wilder's ATR (Average True Range) indicator.  By using this indicator we prevent getting stopped out too soon on the more volatile markets.

Wilder's ATR is calculated for you on most charting platforms and is generally plotted in a 14 period moving average.  ATR is charted (as below) in a box below the main candlestick price chart, when the candles (price action) become longer the ATR moves higher and when the candles get smaller the ATR declines - This represents volatility.  Using the ATR will allow your trade to breathe and stop volatility stopping you out.  The most basic way to place your stops is to double the most recent ATR value and add/subtract to the entry price. 

EUR/USD - Average True Range (ATR) to Calculate Stop Loss

Example:  A simple stop loss as indicated from the above chart where current ATR is 0.01222.
  • Sell EUR/USD 1.30338 (current price)
  • Stop Loss placed 2 x ATR above current price = 1.32782
(Rem. This is a simple example.  In reality we may wait for the down trend to retrace back to resistance before trading and wait for a trade confirmation)

To Sum UP

Technical analysis is not an exact science and although these ideas can increase the probability of making the correct trade, many will go against you and large losses can be incurred. Your own trading strategy needs to be formed and hopefully you'll be on your way to achieving this on completion of this course.

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Introduction

The ATR tells us the average trading range of the market for X amount of time, where X is whatever you want it to be. This Indicator was developed by Wilder as a volatility indicator, reflecting the interest (strength) or otherwise in a market at a particular price. The ATR can be used to validate the enthusiasm behind a move or breakout - much in the same way Volume can.  A bullish reversal with an increase in ATR would show strong buying pressure and reinforce the reversal. A bearish support break with an increase in ATR would show strong selling pressure and reinforce the support break.

We'll also explore using The ATR to help set stop/loss positions.  Having an idea of how much the market is likely to move in the day-to-day noise of the market is always a good idea. This along with other factors already discussed in previous modules can be used to set stop loss positions.  Another use of The ATR is to help Day Traders setting their profit targets.  If you want to exit a trade before the day's end there's no point setting your profit target 2 x the current ATR.

Charting ATR

ATR is based on the True Range over a period of time, which uses absolute price changes. As such, ATR reflects volatility at an absolute level. This means low priced stocks will have lower ATR values than high price stocks - A €/$/£10 security will have a much lower ATR values than a  €/$/£100 security. Because of this, ATR values are not comparable.

For the calculation of ATR, look at this Wikipedia page: http://en.wikipedia.org/wiki/Average_true_range

In the chart below we can see the ATR situated just under the market's price - The default is usually 14-periods.  High values indicate enthusiasm for the market and high price volatility and low values indicate low volatility. Notice how The ATR rises as the trend develops.  There is increased interest in USD/JPY as the price trends up.

USD/JPY - Average True Range

Trading the Break-out with ATR

For Clarity, we're going to talk about trading the break-out of a range, channel or support & resistance here.  NOT The ATR Break-Out, which is a day trading strategy where price breaks above or below the current ATR to form trading signals

The ATR proves to be a very useful indicator.  One of the main uses you'll find is while trading the break-out, one version of which is the directional/non directional bias straddle trade.  At resistance, an increase in ATR show's strong buying pressure and can reinforce a break. A bearish support break with an increase in ATR would show strong selling pressure and reinforce the support break.  This can be especially useful in the Forex market, as the FX market doesn't have a volume indicator as such (although traders use The COT report), so measuring volatility is the next best thing.

Let's look at an example using EUR/CAD where we can use the ATR to determine the health of the break-out.  Over the period of several months the ATR of EUR/CAD has contracted to record lows.  Often, after a period of consolidation the ATR get's lower (As Volume does, indicating waning market demand) and we can see this in the below chart.

EUR/CAD - ATR confirming Break-Out

After marking the low of the ATR and it's high as price breaks through support or resistance (in this case resistance), we can measure the change in volatility.  Any increase in volatility over 10% suggests that there's a lot of capital entering the market at these prices. In this case the increase is 11.36%, which can help confirm the break-out.  In some cases a further confirmation can occur when price re-tests previous support or resistance. 

Entry to this trade may be after 1 full candle moves above or below resistance or support, or you may want to wait for further confirmation, like a re-test of previous resistance or support.  A stop/loss will probably be placed under previous resistance in this case - Money management rules always apply...

Using ATR to Set Stop/Loss

There are many ways to determine stop loss positions.  As we've learned in previous modules some stop loss positions can be set under the last periods open (or over the last periods open if going short), under moving averagestrend linessupport and resistance levels and by using Parabolic SAR.  We can also set stop/loss positions with The ATR and we'll explore this below.

Setting Stops using Volatility Using Average True Range to Set Stop Losses

Having an idea of how much the market is likely to move in the day-to-day noise of the market is always a good idea.  This along with other factors already discussed in previous modules can be used to set stop loss positions. If you are trading a stock that moves €/$/£ 2 a day, or a stock that trades €/$/£ 1 a day, your stop loss may be wider on the former.  But how can you determine the volatility of a market.  We use the Wilder's ATR (Average True Range) indicator.  By using this indicator we prevent getting stopped out too soon on the more volatile markets.

Wilder's ATR is calculated for you on most charting platforms and is generally plotted in a 14 period moving average.  ATR is charted (as below) in a box below the main candlestick price chart, when the candles (price action) become longer the ATR moves higher and when the candles get smaller the ATR declines - This represents volatility.  Using the ATR will allow your trade to breathe and stop volatility stopping you out.  The most basic way to place your stops is to double the most recent ATR value and add/subtract to the entry price. 

EUR/USD - Average True Range (ATR) to Calculate Stop Loss

Example:  A simple stop loss as indicated from the above chart where current ATR is 0.01222.
  • Sell EUR/USD 1.30338 (current price)
  • Stop Loss placed 2 x ATR above current price = 1.32782
(Rem. This is a simple example.  In reality we may wait for the down trend to retrace back to resistance before trading and wait for a trade confirmation)

To Sum UP

Technical analysis is not an exact science and although these ideas can increase the probability of making the correct trade, many will go against you and large losses can be incurred. Your own trading strategy needs to be formed and hopefully you'll be on your way to achieving this on completion of this course.

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