As a trader, one of the key challenges you face is identifying the right indicators to help you make informed trading decisions. Average True Range (ATR) is one such indicator that can provide valuable insights into the volatility of a security. This guide will provide a comprehensive overview of the ATR, including what it is, how it works, and how you can use it to improve your trading strategy.
Average True Range. What is it?
Average True Range is a technical analysis indicator that measures the volatility of a security over a specified period. Traders use ATR to determine the average range of price movement of a security. This indicator was developed by J. Welles Wilder Jr. and was first introduced in his book, “New Concepts in Technical Trading Systems” in 1978.
Average True Range. How it works?
Average True Range is calculated using the true range (TR) of a security. The true range is the largest of the following:
- Today’s high minus today’s low
- Today’s high minus yesterday’s close
- Yesterday’s close minus today’s low
True range is then averaged over a specified period to give the ATR value. Most commonly traders use period of 14 days for the ATR, although they can adjust it based on the trader’s preference.
How Can You Use Average True Range?
The ATR is a versatile indicator that traders use in a number of ways to improve their trading strategy. Some of the most common uses of the ATR include:
- Identifying Breakout Opportunities: When the ATR value is high, it indicates that the security is experiencing high volatility. This can be a good opportunity to enter or exit a trade, depending on the direction of the breakout.
- Setting Stop Losses: that are appropriate for the level of volatility in the security. Traders use a wider stop loss for high volatility securities, while a tighter stop loss for low volatility securities.
- Measuring Risk: the level of risk in a particular trade. By comparing the ATR value to the current price of the security, a trader can determine the risk-to-reward ratio of the trade.
Conclusion
The Average True Range (ATR) is a powerful indicator that can provide valuable insights into the volatility of a security. By understanding how the ATR works and how to use it, traders can improve their trading strategy and make more informed decisions. Whether you’re a novice or an experienced trader, the ATR should be a part of your technical analysis toolkit.