How Can Average True Range (ATR) Improve Your Trading?
Average True Range, known by the acronym ATR, is an indicator widely used in technical analysis in financial market analysis and measures volatility in the market. Welles Wilder Jr. has introduced ATR in his book New Concepts in Technical Trading Systems.
This article will discuss how ATR can help improve your trading and how to use ATR as a stop loss. Stop-loss or sl in forex represents the allowed risk for each trade.
Size/range of the ATR
As the range varies, it is important to take a designated value to measure market volatility. The generally accepted practice is to adapt the best of these: current high less the current flow, the current high absolute value less the previous close, and the current absolute value. It would help if you took the average actual range. It’s more than a moving average. It is determined by using the true range for 14 days.
In this image, we can see on the Daily chart the Average true range. As you can see, GBPUSD is in rising volatility. Price is going down, but volatility is high. It is because of Coronavirus news.
Today, 229 pips are the daily range, and just a week ago, it was around 80 pips.
As a trader, you can use a short period of fewer than 14 days to accrue trading signals. This is because longer periods are likely to generate fewer trading signals. Suppose, for example, a short-term trader wants to evaluate the volatility of a stock during a five-day period.
The trader could have to estimate the ATR for the five-day period. As prices are arranged in the chronological order, the trader gets the absolute value at the maximum level at the current high minus current low, the absolute value of the current high less the preceding close, and the absolute value of the current low less preceding close.
Average True range = ATR = MAX (BarHigh, PreviousBarClose) – MIN (BarLow, PreviousBarClose)
Average true range stop loss you can calculate as Daily ATR percentage or Weekly ATR percentage.
By default, ATR indicator settings are 14 days. In trading, some traders use 24 or 30 too.
As an indicator of the absolute size of the trade
What does the ATR tell us about?
The author of the ATR had the intent to measure the volatility in the commodity market widely known for its volatility. However, note that ATR can also be used to measure the volatility and in stocks and indices.
The way it’s used in the stock market is this: when a stock experiences high volatility, it will cause a higher ATR. Contrary to this, a low volatility stock assumes a lower ATR.
Market experts may use the ATR as an instrument to influence investors – they can advise the latter to exit trades. They can use it as a useful instrument to add to a trading system.
ATR is a helpful tool for market analysis to scale the volatility experienced daily for any asset more correctly. This involves using plain calculations.
Be aware that the indicator does not imply the direction price moves. It can show you the amount of volatility resulting from gaps and the limit that the market goes up or down.
It’s also important to note that the ATR is simple to calculate, and for this, you need data on price on a historical basis. The starting step to calculate the ATR is finding a series of true range values for an asset.
Using ATR for exit and entry
The ATR is widely used as an exit and entry determiner in markets when making such decisions. A commonly used technique is called chandelier exit, invented by Chuck LeBeau’s. Thus, the chandelier exit works: it reckons a trailing stop according to the highest high the stock reached since you entered the trade.
The gap between the highest high and the stop is equal to multiple times the ATR. Thus, you may subtract ATR three times from the highest high at the start when you entered the trade.
So how can we use ATR stop loss for the forex stop loss indicator?
We can set out a stop loss in the function of ATR.
For example :
You can set 20 pips for stop loss if today is 100 pips average true range. But even better you can do:
Instead of 20 pips, you can set stop loss to be 0.2 Daily ATR. If today is 100 pips range, it will 20 pips, but if it is 150 pips range, it will be 30 pips stop loss. Your stop loss is following the current market average true range.
So in your forex stop loss indicator, you need to set stop loss as a function from ATR.
The ATR can also help decide how much you should devote to derivative markets. This is important. You can use it to measure the trader’s amount of inclination to embrace risk and the volatility in the market.
ATR can help in day trading
If you use the ATR as a tool in the day intraday trade chart, the ATR is likely to increase steep following the market’s opening. The ATR spurts even at the beginning of the day, thanks to the high volatility at the moment. The ATR can show that the volatility was more than the preceding trade day.
Once the ART reaches the maximum level, it progressively declines all day. Of course, the indicator’s fluctuation may not provide any information barring the price and its average value at any minute. Likewise, the ATR can show how much each of your assets moves and its moving trend.
You can use the ATR to determine the price reached by your asset at any minute. Such analysis helps predict the tendency in the market movement – the probable trend.
How can you use the ATR forex indicator besides entry and target?
The ATR shows the actual movement in price tendencies. To determine the time that price takes to reach profit live, divide the profit you expect by the ATR. So you can connect ATR and profit as well.
As a guide to exit the market
You can use the ATR to leave the market if you find the assets’ price moves against your expectations. It can guide you when you should decide to exit the market.
By this, you can protect yourself against potential loss by knowing the market movement tendency beforehand.
How it works
It would help if you took note of the ATR value at the moment. You can find out the suitable limit by double the ATR. Thus, when you buy a stock that is losing, you can arrest the loss at ATRx2. The loss increases and reaches the peak level and stays there until the close of trade because of the drop in price that could impact the stop loss level. For short trades as well, this mechanism works.
The ATR indicator is a great tool that helps traders determine the right amount of money they should devote at the right time. Of course, you should have enough exposure to the market – how to use the tool and the potential impact on the ultimate findings. By using the tool judiciously, you can protect your money without having to spend a lot of time that would otherwise you squander. You can, thus, start trader on the day, and you can also sense when you should devote more money to the market, and you can sense the threatening perception and exit the market.