Average True Range

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21 Aug, 2024

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Average True Range (ATR) refers to a technical analysis indicator calculating market or price volatility. It helps analyze the volatility involved in price changes of any security, then select the best time for trading and achieve consistency in trading.

This technique was introduced by J. Welles Wilder in his book "New Concepts in Technical Trading Systems" in 1978 to examine the commodity risk by calculating the volatility of the commodity. However, even though it is used to predict trends, it does not indicate the direction of price movements.

What is the Average True Range?

The Average True Range refers to a technical analysis indicator that measures the volatility of an asset’s or security’s price action. The ATR was introduced by J. Welles Wilder in his book “New Concepts in Technical Trading Systems” in 1978.
The ATR formula is “/n” where TR = max .
ATR values are primarily calculated on 14-day periods. Also, analysts use it to measure volatility for any specific duration spanning from intraday time frames to larger time frames.
A high value of ATR implies high volatility, and a low value of ATR indicates low volatility or market sideways.

How Average True Range Indicator Work?

The Average True Range indicator application enables the prediction of the trend change by utilizing the average of True Ranges and revealing the volatility. If the ATR value rises, there is high volatility and a high probability of trend change. Similarly, a low ATR refers to lower price volatility. Hence along with trend changes, it also gives signals of Market Sideways, which is otherwise difficult to determine unless indicators like Average Directional Index (ADX) and Directional Movement Index (DMI) are used. In essence, it follows the fundamental notion of a security's range (high price– low price); if the range is high, volatility is high and vice versa.

In the chart from TradingView given below, the range is clearly visible, and the buy and sell points are marked, which the traders typically use to decide their entry or exit points. The points marked in green show the buy points since they are the prices from where there is a possibility of an uptrend. Similarly, the points marked in red show the overbought points from where the market has the possibility of going down.

Source

ATR indicator is non-directional. It is more aligned with predicting the occurrence of trend change rather than predicting its accurate direction. It never specifies the direction, like whether a bullish sentiment will happen or not. It is more useful as an indicator for finding breakout points, detecting entry signals, deciding target profits, stop-loss placements, or a volatility stop. Also, it is always used in association with other indicators like support and resistance indicators and trendlines. The Turtle Trading System, Chandelier Exit, and Keltner Channels are examples of the "Average True Range Band" applications.

ATR measure is a universal indicator since it can measure the volatility of price changes of different asset classes or markets. Also, it is used to measure volatility for any specific duration spanning from intraday time frames to larger time frames. It helps active traders trade when the market is ready to accelerate.

Average True Range Formula & Calculation

The prime component of the ATR formula is the True Range (TR) value. The TR (Current TR) is the greatest of the following:

Current high minus current low: (current high – current low)
Current high minus previous (yesterday's) close: absolute(current high – previous close)
Current low minus previous (yesterday's) close: absolute(current low– previous close)

TR = max

The above formula for TR indicates that ATR calculation includes the Open, High, Low, and Close values of assets. Normally, the value of n is 14 by default since it is believed that a 14-day period gives the most reliable output, and ATR discloses the average volatility over the past 14 days.

Examples

ATR as a tool for measuring the volatility of stocks, forex and commodities can also be used in crypto trading. It is well suited in a crypto environment because of the high volatility explained by the exponential escalation and plunging of crypto prices. The method can calculate the range of cryptocurrencies like bitcoin price movement for a specific period. However, ATR does not directly indicate the direction of the Bitcoin trend. Instead, it gives a trend change signal. The higher the ATR value, the higher the chance of the bitcoin trend changes, and the lower the value, the weaker the fluctuating movement.

Example 1

Wall Street rallied for a third day continuously. The momentum shows daily ranges for the major indices, all below their average true range indicator. But this is expected from a tactical viewpoint as it goes forward to edge their record highs. One more week is under speculation of potential chop before the rally hopefully kicks in. A hike in Q1 was dispelled by still vowing to keep rates low so that 2% CPI is achieved in the middle quarters of 2022. It indicates that April is the earliest to hike.

Example 2

Besides the ongoing energy crisis still coming forward, the German stocks rose even after that. The gas prices jumped by 10% after the German foreign minister declared that the Nord Stream gas pipeline could not be permitted because of noncompliance with European law. The gas pipeline is anticipated to double the undersea cable's capacity from Russia to Europe. The rising gas prices will probably lead to higher inflation and the cost of doing business in Germany and other European countries. As a result, the DAX index rose to 15,765 euros. The Japanese yen showed a little movement just after the latest Tankan sentiment data. And the Bank of Japan has reported the large non-manufacturers index hiked from 2 to 9 in Q4 from Q3.

The USDJPY was showed variation after the latest Japan sentiment data. The pair trades around 113.62 for a few days and is below the 23.6% Fibonacci retracement level, along with the 25-day and 50-day moving averages. However, the MACD and the average true range indicator (ATR) show that it has not been volatile. Therefore, the pair is assumed to remain in this range during the American session.

Frequently Asked Questions (FAQs)

What is the Average True Range indicator strategy?

It is the application of ATR as a technical analysis indicator to measure price volatility. The techniques utilize the values of open, high, low, and close securities positions to determine ATR and how much the asset price moves on average. Using this strategy eases the identification of the point at which the price of an asset moves above a resistance area or moves below a support area that is the breakout point.

How do you calculate the Average True Range?

The ATR calculation starts with selecting the True Range based on one easy method. It is the largest value of (current high - current low), Absolute(current high - previous close), Absolute(current low - previous close). Subsequently, Current ATR is the output of "/n".

What is the best ATR setting?

The ATR is calculated for a particular amount of time. The formula calculates ATR for n period. In practice, the usual value given for n is 14 days or 14 periods. However, professionals use different settings to find intraday, daily, weekly, or monthly values. Sometimes it can be a period below 10 to calculate a shorter average or a period more than 20 days for assessing longer-term volatility.