2023.01.31 2023.01.31
Average True Range – the ATR Indicator: improve your trading with volatility measureOleg Tkachenkohttps://www.litefinance.org/blog/authors/oleg-tkachenko/
The ATR (Average True Range) indicator is a useful tool that measures volatility levels.
The ATR indicator meaning tells us how much the price has changed in a current period compared with previous periods. It is used in trend strategies to assess a trend reversal probability and determine the moment when the market starts a new trend. It also serves to place Stop Loss and Take Profit orders and is used for estimating the range’s width when trading results based on channel strategies.
The technical indicator is included by default in many trading platforms and applied as an auxiliary indicator combined with Price Action and oscillators.
The article covers the following subjects:
What is ATR: average true range full definition
Technical analysis indicators can be divided into three groups:
The ATR Forex market indicator is often considered to be an oscillator as it helps us define new trend reversal points. If the indicator covers over 75% of its average distance in a fixed time period, there can be a reversal. Unlike oscillators, it hasn’t got the “0” and “100” limits that define overbought and oversold territories. Thus, the ATR indicator is a specific technical indicator that combines the three groups’ features.
The Average True Range was first introduced by J. Welles Wilder in 1978.
J. Welles Wilder also developed such popular tools as Parabolic SAR and RSI. The technical indicator was first meant for futures markets, which are much more volatile than stock markets. Then it grew so popular that it was included in trading platforms (including trading Forex, trading CFDs, and working with other complex instruments) as a basic one.
J. Welles Wilder created the ATR indicator for one purpose: determining market high and low volatility.
Average true range trading is rarely applied to manual strategies, but it is often used for forming trading advisors’ automatic risk management trading systems. This technical indicator doesn’t measure a trend’s strength and cannot forecast price movements. It only estimates market high and low volatility.
That said, the average true range is the indispensable tool for setting profit target levels, stop placement orders, and determining the width of price channels in channel and range strategies (strategies used for trading retracements and breakouts).
The ATR indicator is NOT used for:
determining a price market direction;
searching for a divergence;
it can sometimes indicate reversal points;
it is used for measuring price ranges and the nature of their trend changes.
The indicator’s main signal is the following: when the indicator grows, an asset’s volatility grows. The classic error is to link the indicator’s growth to price growth. The ATR indicator doesn’t show the price’s direction either. When it grows, the price line may rise or fall. It’s the price volatility range that increases.
What is Average True Range?
ATR measures volatility over a certain period. It compares:
Then it takes the greatest of those values and averages them out based on the arithmetic mean.
The indicator’s relatively low values can be read as follows:
The market is flat. The price moves in the same range, and the average difference between highs and lows doesn’t change. However, we cannot estimate the range’s width where the price fluctuates using the ATR indicator.
The market trend is slow. The price grows or falls, but the difference between neighboring candles isn’t significant.
The indicator’s leading signal is a sharp increase in its readings that indicates a rising difference in candlestick extremums. The candles’ bodies and shadows are growing, and the price’s angle of ascent relative to the horizontal axis becomes bigger. At the same time, the price range may remain the same. Volatility growth means that the price covers the same distance faster.
Example of using the average true range indicator:
There’s a small downtrend in the market; the ATR (Average True Range) value is small.
Then, there’s a sharp high volatility splash: the price range is growing sharply over a short time period. The Average True Range is rising steeply. Next, a slow uptrend begins. Although the distance between the trend’s start and top is many times bigger than the volatile segment’s range, the ATR (Average True Range) is reducing because the trend has been developing over a certain time period.
ATR indicator formula
There are three formulas how to calculate ATR true range:
The difference between a current candle’s extremums (high and low). The current candle’s high less low.
Absolute value of the current Max (High) less the previous value of the close. |High — (Close-1)|.
Absolute value of the current period Min (Low) less the previous value of the close. |Low — (Close-1)|.
Then we take the greatest value of those and calculate the ATR indicator’s readings. Here’s the formula:
ATR = Moving Average (TR, m)
where TR is the greatest value out of the three differences and m is an averaging period. Moving average is the arithmetic mean of a given set of values.
Average True Range calculation
Now let’s find out how to calculate the ATR true range value to better understand its work principle. I remind you that the Average True Range is the greatest value of the following: current period high minus current low; absolute value of current high minus previous close; absolute value of current low minus previous close. The indicator compares those three values for two neighboring candles. The period is the number of candles considered.
For example, if the period’s value is 1, the ATR indicator will compute the difference of prices for the latest candle. It will compare its High/Low, and the difference between the candle’s High/Low and the previous close of the candle. So, with period “1”, two candles are considered. For example:
The difference between high and low: 1.2121 – 1.2117 = 0.0004, or four points for 4-digit quotes. That is the greatest value of the three possible remainders.
The print screen shows that the value is identical to ATR true range calculation. “0.0004” means that the average true range is four points for one candle period.
If we take period 2, the three latest candles will be considered. The two values for the ultimate and the penultimate candles are averaged: they are summed and divided by two, according to the arithmetic mean.
The longer the period, the more candles are considered, and the smoother the ATR line gets. However, remember that ATR reacts slower to price moves when the period gets longer.
How can volatility indicator help while trading?
This useful indicator identifies the moment when the price range starts enlarging sharply. This feature can be used for the following purposes:
To form short-term strategies. A sharp volatility surge is a perfect moment for scalping. You can check my article Forex scalping to learn more about this type of Forex market strategy.
To decide in your trading strategy in which direction a trade should be opened. If the Average True Range covered half its mean range, it’s probably too late to open a trade in the market direction of the trend, and you’d better wait for a reversal.
To determine price targets. Take Profit is placed at the volatility range limit or within the range. If the Average True Range is 60 points, Take Profit can be set at 45-50 points relative to the opening price.
To determine Stop Loss levels. Stop Loss is placed outside the price high and low volatility range and linked to the ATR correction multiplier. ATR correction multipliers are calculated separately for each specific asset.
What Does ATR Indicator Tell You?
The ATR indicator has got just one signal: it rises or falls. The higher the ATR line is, the more volatile the market is, and the faster the trend line moves from one range limit to the other.
In segment 1, the indicator is moving horizontally. It means the market is flat: the amplitude of price fluctuations and candlesticks’ size are small.
In segment 2, the ATR value is surging, and the indicator starts growing. It means volatility is increasing, and we should look for an entry point. As the ATR doesn’t indicate a price direction, we shall determine it ourselves. For example, draw support and resistance levels through the flat range’s extremums and open a trade in a breakout direction.
In segment 3, there remains high volatility, but the trend is changing direction. A trader’s task is to catch the price line reversal on time and reverse the trade when volatility is still high.
In segment 4, the indicator is returning to its lowest values in a flat range. It means volatility is declining; the pace of price changes is slowing down; the amplitude where the price fluctuates is decreasing; the candles’ bodies are becoming shorter than the candles in segments 2 and 3. That can indicate a flat market or a trend slowdown. In our case, we have a slow downtrend. It’s a signal for swing-traders and scalpers to exit the market.
Here’s how we can use the ATR’s signal about a rise in volatility:
A new trend’s start is a signal to open a short-term trade to catch the fastest price movement in either direction over a short period. It’s one of the options for scalpers.
A sharp increase in the price movement amplitude is a signal to exit the market or increase stop placement orders’ value. Suppose we have a medium- or long-term trade, and the stop order value was calculated based on the maximum possible drawdown, according to our own risk management rules. We see that the volatility is growing sharply. We have two options: to close the trade earlier before the price reaches the stop level or top up our retail investor accounts, increase the stop value, and wait for a temporary drawdown to end. Without a robust trading strategy, there is a high risk of losing money rapidly.
This volatility indicator doesn’t point to overbought/oversold areas, so its readings are estimated compared to the readings over prior ATR periods by zooming out the chart. Volatility levels don’t depend on a price direction. The ATR line can be rising, while the price can be moving up or down.
Day trading ATR
Large time frames are usually used for preliminary analysis. The main time frame can be H1, and the time frame analyzed can be D1.
Example: let’s use ATR and see how it measures volatility for the USDCAD on the daily time frame.
With period 14, the value is 0.0077. It means that the price’s average true range is 77 points over the last 14 trading days. Switch to the H1 time frame and check how far the price moved since 00:00 up to this moment:
The daily range’s open price at 00:00 is 1.26799 (rounded to 1.2680); the current period price is 1.2661. There’s a powerful downtrend that other indicators can confirm too. The price fluctuates down by almost 20 points, with average volatility being 77 points. Theoretically, if the price line has not covered 50% of the average true range, we can open a trade in the trend direction. The market entry point for a short position is the current candle.
If the price has covered over 50% of the ATR, wait for a while. Think about opening a trade in the opposite direction of the trend if the price covers 70%-80% of the daily ATR. This method isn’t flawless, but it can be one of the options when determining market entry points and the price direction.
The ATR Indicator in MT4
The Average True Range indicator is one of the basic ones in MetaTrader 4 and MetaTrader 5. You can find it in the “Indicators/Oscillators” menu.
ATR true range settings for MT4
In the ATR settings Period is the main parameter. Using the same window, you can set Maximum and Minimum levels. That’s convenient for visually comparing previous periods’ volatility with a current period’s one. Memorizing values isn’t convenient: it’s easier to set the levels and check deviations from a current value by scrolling the chart. The chart will display only the time limits specified in the ATR settings.
You can fix the value of the level in the “Levels” tab, and it will be displayed as a horizontal line in the chart. For example, as the red line in the print screen below.
One of the drawbacks of displaying the indicator in МТ4 is that only the current value is shown next to its name (the blue rectangle), and it won’t have significant change when you’re scrolling. You can put the cursor on a point and wait for a pop-up window or activate the “Data Window” (Ctrl+D). Both options aren’t convenient to me.
The Visualization tab shows how the indicator will be displayed on a selected time frame. For example, you’re analyzing the chart on several time frames, and you need ATR on the daily time frame. You tick D1, and the indicator will disappear when you switch to other time frames.
There are various modifications of the indicator on the Internet. You can download ATR Ratio on the MQL5 site (Short-term ATR / Long-term ATR ratio).
The template can be added to the platform. Please let me know if you want to learn more about those modifications and work strategies based on them.
ATR settings on LiteFinance’s online platform
How you can find how to manage the ATR settings on LiteFinance’s platform:
Go to “For Beginners/Open a demo account” in the homepage’s upper menu. You will be automatically redirected to a free demo account on LiteFinance’s online platform. Registration isn’t necessary.
Click “Trade” in the left menu. Choose your trading financial instruments. Let’s say the EURUSD pair in the “Currencies” tab.
On the price chart that appears, click on “Indicators” and select “Average True Range.”
ATR settings on LiteFinance’s online platform
There are a few ATR settings:
1. Depth (period)
The default value is 14, which means the indicator uses the last 14 candlesticks. For short periods up to M15, it is recommended to increase that period. For time frames longer than H4 – decrease that period. For example, many traders prefer period 7 for the D1 time frame.
An asset’s peculiarities should also be considered: some pairs are more volatile than others. So, it would be wise to shorten the period for low values of assets’ volatility to increase the indicator’s sensitivity to price changes.
2. Smoothing
It’s about the type of MA that the indicators are based on. There are four options. This parameter doesn’t influence the ATR line’s plotting significantly, but the value can vary, and that can be a decisive moment for high-precision strategies.
3. Accuracy
The parameter varies from 0 to 8 and sets the number of digits after the decimal point.
You can change the line color in the “Style” tab.
In contrast to MT4, you can see the indicator’s value by placing a mouse pointer to it.
How to use ATR indicator
Average True range is most often used in the following cases:
To determine Stop Loss levels. Volatility levels outline the range of price movements. The limits of that range can be a reference point.
To determine flat periods. If the ATR value is low when compared with average volatility, the market is flat.
To identify the end of a trend. The farther the price line goes beyond the ATR limits, the likelier it is to stop.
Placing Stop Loss orders
Stop orders are usually placed in the area of local extremums with a slight indent. The question is how to correctly identify local extremums and not let price noise trigger stop orders.
To place stop orders using ATR, we need to do the following:
Draw support and resistance levels through the most evident extremums on a short time frame (М5-М15).
Add/subtract 2*ATR to/from the price value of the candle’s ultimate extremum. The value you get is a Stop Loss level. The multiplier “2” should be adjusted to each specific pair. At least 1.5 ATR is recommended. The best ATR Stop Loss multiplier for time frames starting from H1 is “3”.
There’s a different method: place a stop order at the level when opening a trade. Subtract or add a few points from that value for filtering. To place Take Profit, switch to a bigger time frame and check the financial instruments’ level there.
This method works the best on short time frames with price noise — the price line’s chaotic, unpredictable price movements in either direction. Using the indicator allows us to place stop orders at a safe level, providing for price noise.
Example
During a downtrend, draw a resistance level to open a trade after its breakout, confirmed by the pattern. Open a long position on a pullback. Minimum price — 1.19588, ATR — 0.0005 or five points. Multiply 0.0005 by two and subtract the value from the minimum price. You’ll get the Stop Loss level of 1.19488. As the print screen shows, the price line didn’t get to that level. It tested the level of 1.19516 and then reversed upwards.
Flat filter
You earn from a trending currency pair with medium daily volatility of 80 points. I got this number using a volatility calculator. If current period volatility is less than 50% of that range, the market can be considered flat. So, if the value is less than 40 points, we don’t search for entry points using trend strategies as any direction of quotes will hardly last for a long time.
It’s hard to say if it’s reasonable to follow that scheme. First, the value of 50% is conventional and should be readjusted to each particular pair. Second, the market can be trending on smaller time frames.
The instrument’s drawbacks are lags, which is true of all moving averages. The longer the period, the less sensitive the instrument is to current price changes. For example, if you set the period at 50, the indicator will consider 50 last candlesticks. If the price changes sharply on the two or three last candles, such trend changes will be absorbed by the previous candles’ values. On the other hand, a short time frame can produce a lot of false trading signals. So, all the minuses of moving averages are typical here too.
Example:
The EURUSD’s average volatility over the past performance during the week was 44.25 points.
The ATR current value on 4-digit quotes was 61 points on the daily chart. As the current volatility is higher than average, the market isn’t flat, and the current trend is a bit stronger than the weekly one.
Determining potential trend reversal points
The bigger the indicator wave’s amplitude is relative to its previous values, the likelier the price line is to reverse.
Example
A relatively low ATR value couldn’t say if there was a trend on the daily chart. There was an uptrend, but its pace was so slow that the Average True Range couldn’t identify it.
The indicator’s steep growth indicates that market volatility is rising: the price’s angle of ascent is increasing, and the price is changing faster. The trader only needs to predict the trend’s direction.
ATR reaching the maximum and reversing means that volatility has started to fall. Note that the trend changed its direction while the indicator line was growing. Let me remind you that the Average True Range doesn’t indicate price directions; it only shows a relative price change speed. The indicator’s return to its current lows means that the price change speed is declining: the market is becoming flat or trending slower.
There’s another way to identify pivot points. The average true range value is compared with the distance that the price has covered from the beginning of a time frame to the present moment. A shorter time frame is used for comparison.
Example. Let’s take as 100% the H1 ATR value, which shows a price movement’s average true range over the past hour. Then switch to the one-minute time frame and find where the current H1 time frame begins. Estimate the price distance covered up to the present moment.
If the price line went farther than 70%, a reversal is highly likely to happen. Think about opening an opposite position.
If the price line covered less than 30% of the distance, think about opening a trade in the trend direction.
If the distance varies from 30% to 70% of the range, take your time.
Those values are just a reference point. They are specific to each particular asset.
ATR trading strategies
Trading on several time frames using levels and ATR. Most strategies have already been described above. I’ll show you how to use them in practice.
Step 1. Daily time frame analysis
Open the GBPUSD’s daily chart and check the trend.
The chart shows a strong, steady trend that started after a dramatic drawdown. Note a sharp ATR surge during the downtrend: one could profit from short positions there. A smooth uptrend continues; there are several consecutive growing candles with small bodies. The ATR indicates there’s no strong volatility. That means the price is expected to continue rising smoothly. The ATR value is 92 points.
Step 2. Short-term time frame analysis
Then switch to the M15 chart and check how many points the price has covered since the daily opening.
The opening price was 1.38988 at 00:00. By the morning, the price gained almost 55 points and then came back. ATR indicates high volatility. As the daily range is 92 points and the price isn’t far from the start, we can presume that the uptrend will continue.
Step 3. Opening of a trade
Let’s sum up: we decided to open a long position because:
There’s a slow uptrend with low volatility on the daily time frame.
The M15 time frame is showing a resistance level from which the price has just pulled back upwards.
The price has covered nearly 50% of its daily volatility and partly corrected back to the daily range’s start point.
So, I open a trade at 1.39236 (almost 25% of the daily range equal to 92 points). Stop Loss: current ATR*2, which equals 14 points. A multiplier of 3 would probably be better: Stop Loss would be located a bit below the opening price of 1.38988. Take Profit: 75% of daily ATR.
The volume of a position should be determined individually and depends on your goals and deposit.
Close the trade based on Take Profit or when a clear reversal pattern appears. I don’t think it will appear before the daily ATR reaches 50%, though. The profit target is 5 USD.
Step 4. Closing a trade
4.1. Conservative scenario
Everyone has their own profit targets, but I’d recommend that beginner traders shouldn’t wait for Take Profit to trigger and should fix current profit targets at the first reversal.
If you see that the price cannot decide its direction during a high volatility period, like in this market conditions, close the trade. Closing price: 1.39385. Profits in 2.5 hours: around 15 points minus spreads.
4.2. Aggressive scenario
The target is to make the most profits based on the ATR theory. I’m not in a hurry to close a trade, and I hold it. As a result, it closed at Stop Loss at minus 1.51 USD. The market analysis revealed a mistake. The market volatility is still high, but there was a clear trend shift. The arrow in the print screen below marks the opening point.
The daily candlestick is downward. So, I open a counter trade using the same principle: the opening price at 00:00 (1.38988) marks the beginning of the volatility range, but the trend is downward now. The volume can be doubled.
It took me 30 minutes to claw back the loss from the previous trade and earn 0.5 USD. I fixed the profit from the second trade for psychological reasons: to cover the previous loss.
Key points:
The ATR indicator shows current volatility shifts. However, the examples proved that the price could change its direction within a few hours. That can be used in Swing trading strategies.
To calculate Stop Loss for a short time frame, we’d better use multipliers equal to or less than 2. I’m open to further discussions regarding the issue, though.
There are two market exit strategies. The first one suggests exiting at the first trend reversal. The other one implies using Take Profit calculated based on ATR. If a trade hasn’t closed by the end of the day, close it manually. If a trade is closed at Stop Loss, try to open a counter position.
You can use hedging or Trailing Stop.
ATR Trailing Stop Loss
Trailing Stop Loss is a Stop Loss order that follows the price in the direction of a trade and stays at the taken level if the price reverses.
Volatility is measured only by the price range over a fixed time frame. The price can move in any direction. If we open a trade and place a regular Stop Loss order when the price went outside a flat range, we can have the following scenario: the price reaches fast the opposite limit of the volatility range and gets back. Here’s an example in the print screen below.
Average True Range starts growing, and we can open a long position in point 1. If a trader is eyeing the chart all the time, he/she will close the trade based on patterns in point 2. If he/she misses that moment, he/she will lose profits and make losses in point 3. The price will have gone through the entire volatility range and backward within a few hours.
Using ATR Trailing Stop allows us to fix at least some parts of profit and avoid closing a trade at loss during high volatility. Theoretically, the Trailing stop’s value is ATR*k, where “k” is a volatility multiplier set manually. Most often, it’s “2”, “2.5” or “3”: the higher the time frame, the bigger the multiplier.
The same example: a long position is opened at 1.26776 in point 1 and secured with Trailing Stop set at 2*0.0006, i.e., 12 points, which equals the ATR value registered at the trade’s opening. If the trade is secured with Trailing Stop, it will be automatically closed in point 2. If we deduct spreads, the profit will be around 15-17 points on 4-digit quotes in two hours. Without Trailing Stop, the trade would have been closed at 12-point loss plus spreads.
How to set Trailing Stop on LiteFinance’s platform:
Set the position sizing of a trade and open it in one click.
Open the “Portfolio” menu in the lower part of your platform and click “Edit”.
Set Trailing Stop in the window that opens.
ATR stock trading
The instrument’s application to the stock market is the same. Average True Range estimates trading activity and most traders’ interest in a stock. If the indicator’s value is growing, volatility and trade volumes are growing too. If the value is low, the market is flat. In addition to ATR, you can use the volume indicator or the depth of market (DOM) in MT5 to check powerful support and resistance levels.
The indicator is even more useful when financial reports, press releases, or other stats are published. It helps us to see:
Market reaction – how fast and violently the market reacts to the news.
Market volatility levels concerning specific newsworthy occurrences; what type of news provokes a stronger market reaction.
Volatility degree: how long a high volatility period lasts after statistics are released.
Correlation: which releases are interrelated? For example, will Apple’s financial reports affect other technological companies’ quotes?
Another important aid will be the Economic calendar and financial calendar. Have a try and use ATR on the Tesla (TSLA) chart, for example.
Downsides of ATR
The Average True Range has got some downsides too:
Limited area of application. It doesn’t show asset’s price directions or provide forecasts. It only estimates general volatility levels compared with previous periods.
Lags. Specific average true range formula. Volatility can start growing, but the indicator’s value will still be low. Lagging can last across 1-2 candlesticks.
Though ATR belongs to the oscillators group, it’s best applied in combination with Stochastic, MACD, and other oscillators. Also, short periods will work better: the period of 12-14 is optimum on the H1 time frame.
Key points
Volatility indicators are necessary for professional trading. They aren’t informative enough for beginner traders to appreciate them more than other tools. Nevertheless, it’s worth mentioning as some may need them for developing their trading strategies.
Would you like to download the ATR indicator free? Don’t hustle. It’s a basic indicator on MT4 and MT5 platforms, and you can get used to it on demo retail investor accounts. If ATR isn’t there for some reason, you can reinstall the platform or copy the setup file from the MQL/Indicators folder from the platform installed on another computer. You can also find ATR on LiteFinance’s platform integrated into the Client Area. You don’t need to install it.
I hope this article has been useful for you. If you’ve got any questions left, ask them in the comments section. Good luck in trading!
P.S. Did you like my article? Share it in social networks: it will be the best “thank you” 🙂
Ask me questions and comment below. I’ll be glad to answer your questions and give necessary explanations.
Useful links:
I recommend trying to trade with a reliable broker here. The system allows you to trade by yourself or copy successful traders from all across the globe.Use my promo-code BLOG for getting deposit bonus 50% on LiteFinance platform. Just enter this code in the appropriate field while depositing your trading account.Telegram chat for traders: https://t.me/litefinancebrokerchat. We are sharing the signals and trading experienceTelegram channel with high-quality analytics, Forex reviews, training articles, and other useful things for traders https://t.me/liteforex
The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.
Rate this article:
{{value}} ( {{count}} {{title}} )
Source link
![TESLA ($TSLA) impulsive rally favors upside [Video]](https://editorial.fxstreet.com/images/Markets/Equities/display-panel-of-daily-stock-market-59908972_Large.jpg)
