ATR Trailing Stop

ATR Trailing Stop is a technical indicator that traders use to decide the stop loss levels while taking a trade. This is important to control the loss in case the market does not move in the desired direction.

This concept involves calculation using the Average True Range, which suggests to the traders whether they should buy or sell. The charting platforms offer flexible parameters that account for price fluctuations. However, it should be combined with other indicators for better confirmation.

ATR Trailing Stop is a widely used technical indicator that guides traders regarding the ideal stop loss levels when taking a buy or sell trade. It uses the Average True Range method for calculation, which gives precise levels that control the risk of loss to quite a large extent in case the market does not move in the predicted direction. 

In the year 1978, J. Welles Wilder Jr. invented the ATR trailing stop indicator. Since then, the concept has gained popularity among traders because it identifies stop loss levels after considering market volatility, which makes the trade less likely to reach the exit price soon. 

This trailing stop concept is used to decide whether to enter and remain or to exit the market by pointing out the ongoing and future trends in price. It is necessary to know the parameters that traders should use in the charting platform for different time frames so that higher price fluctuations are taken into account to reduce the effect of volatility. 

Uptrend and downtrend in the market are the results and conclusions that traders derive from plotting ATR trailing stop and looking at whether it is above or below the price range. However, it is not a standalone indicator and may sometimes give false signals which misguide the trader. However, it continues to remain a valuable tool for risk management. 

Here is the formula to calculate the ATR trailing stop indicator. The concept uses the Average True Range method, which is as follows:

ATR = (1/n) * (Σ (True Range))

In the above formula, n represents the number of periods. The Σ (True Range) denotes the summation of all those periods. After that, the average of those actual ranges is calculated. There are a few steps for that, too. 

• First, the value of the current high is taken minus the current low. 
• Then, the calculation considers the absolute value of the current high minus the previous close. 
• Then, the calculation considers the absolute value of the current low minus the previous close. 

Finally, the ATR trailing stop loss calculation involves multiplying the ATR by either point 2 or point 3. Then, the result is either subtracted from the highest high or added to the lowest low. This will depend on the trend direction.

Trading using this indicator is attractive to understand with the help of a chart from TradingView. In the chart given below, the ATR trailing stop is plotted. It also points out the buy and the sell positions, which are marked with blue and red, respectively, and the trader can use them to enter the market or exit the trade. 

From the chart, it is possible to understand that whenever the actual prices are above the trailing stop, there is an uptrend in the financial instrument. The prices falling below the trailing stop indicate a downtrend in the market. Therefore, this indicator identifies trends and direction and gives information about what the trader should do next with respect to prices. The points at which there is a crossover, there is a trend reversal. 

The ATR trailing stop loss created clearly shows how it covers a vast range of price fluctuations and indicates the levels that can be used for taking trades. When the trader plots it on the chart, the value of the ATR is already calculated. 

Source

It is possible to understand the concept with the help of some suitable examples, as given below:

Example #1

Ben is an intra-day trader who is looking to enter the market at a favorable point. Therefore, he uses the ATR trailing stop to identify an entry point and also decides the stop loss level. He notices that the indicator is moving below the price level, signifying a bullish market. But at a particular point, the indicator makes a crossover and moves above the price level, which means there is a trend reversal to bearish. He verifies the trend with MACD and RSI and takes a short position to take advantage of the fall in the market. 

Example #2

The concept of ATR trailing stop loss strategy is visible in the chart given below, where the trailing stop loss line is drawn in the chart of Tesla. The crossover points that rise above the price levels eventually show a downward trend, and the opposite happens when the crossover happens upwards, and the ATR moves above the price level. The buy levels are the lowest points in green, and the sell levels are the highest points in red.

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Some benefits of the concept of ATR trailing stop loss strategy are given below:

• The method takes into account the volatility of price fluctuations. Suppose the trader uses a higher multiple while setting the parameter in the chart. In that case, this will ensure a wider stop, accommodating more fluctuations, and a lower multiple will allow or accommodate fewer fluctuations. 
• It is a good tool for risk management because it can adjust to changes in market conditions. 
• Since it also confirms the direction or trend of the market, it is possible to get information about which way the market is moving. 

Some drawbacks of the ATR trailing stop strategy are given below:

• It is not an indicator that will give accurate results in all cases. Therefore, it definitely generates false signals in many cases that may misguide the trader or investor, leading to loss.
• It may not be suitable for all types of trades or strategies followed in the market. Thus, the trader has to have thorough knowledge about it and implement it in the best possible situations. 
• It has a lagging nature, which means it will not always provide the proper signal when the price change actually occurs. This may result in delays in taking trade and missed opportunities. 

Even though both the above are technical indicators used for analysis or trade-related decisions, there are some differences between them, which are as given below:

• The chandelier exit is basically a stop-loss indicator that uses the average true range (ATR) in its calculation. Therefore, the chandelier exit uses the ATR as its parameter. 
• The chandelier exit will determine the entry and exit positions by incorporating the ATR in its calculation. However, the ATR training stop does not have any role for a chandelier exit. 
• The ATR trailing stop strategy uses the current market prices or the current highs and lows in its calculation. However, the latter does not use the current market price. Instead, it takes the highest high and lowest low for the “n” number of periods.