Advanced technical analysis
Average true range (ATR)
- What is average true range?
- How to calculate average true range
- Trading with average true range
- Average true range factsheet
The average true range indicator is popular among technical traders as a means of quickly identifying market volatility. Let's take a look at how it works.
What is average true range?
Average true range (ATR) is a technical indicator that appears as a single line in a box underneath a market's chart. When the line rises, it means that the market is becoming more volatile. When it drops, volatility is falling.
The standard ATR setting is 14, so it calculates the average of the true range over the past 14 periods. That average value is displayed as a dotted line.
ATR was originally invented for use on commodities, but traders now use it across multiple asset classes.
How to calculate average true range
Much as the name suggests, ATR is a moving average of a market's true range. To calculate true range, you need three figures:
- The current market high minus its current low
- The current high minus the previous close
- The current low minus the previous close
Whichever figure is greatest out of the three is the true range.
For example, let's say USD/JPY hits a high of 113.73 and a low of 113.32 in today's session, after previously closing at 113.98.
- 113.73 - 113.32 = .41
- 113.73 - 113.98 = -.25
- 113.32 - 113.98 = -.73
The greatest figure of the three is -.73. So, the high minus the low provides the current true range.
It doesn't matter than one of the figures is negative – ATR takes the highest absolute value into account.
By default, the ATR indicator takes the true range of the last 14 sessions and converts it into a moving average, which is shown as a line.
As with most indicators, you can tweak it to include as many sessions as you want. Short-term traders often use ATRs of ten sessions or fewer.
Trading with average true range
As a measure of volatility, ATR is frequently used to evaluate trading opportunities – including whether to trade, and where to place stops and limits.
ATR and market moves
Using ATR, you can quickly see how much a market typically moves in any given day. This can be useful when deciding whether to trade a signal provided by another indicator.
For instance, ATR might tell you that a market only tends to move 20 points in a given session. If you spot a sell opportunity, but the market has already dropped 25 points, you might want to reconsider trading.
Stops and limits with ATR
Similarly, ATR can be used to determine where to set profit targets and stop losses. If a market moves 20 points each day, then targeting a 50-point profit from the current session might be unrealistic.
This also helps with setting stops. If a market is more volatile than usual, you might need to place your stop further from the current price to avoid getting closed out early. However, remember that this will increase your overall risk.
Average true range factsheet
|Used in:||Any conditions|
|Used for:||Measuring volatility and evaluating opportunities|