Average True Range (ATR)

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Average True Range (ATR)

What is ATR?

The Average True Range (ATR) is a volatility indicator introduced by J. Welles Wilder Jr. It quantifies how much an asset’s price typically moves over a given period, without indicating price direction. ATR is most commonly calculated using a 14-period moving average of the True Range (TR).

Why use ATR?

  • Measures market volatility (including gaps and limit moves).
  • Helps set stops and position size based on volatility.
  • Can signal breakout strength when combined with price action.
  • Applicable to commodities, stocks, indices and derivatives.

How to calculate ATR

  1. Compute True Range (TR) for each period:
    TR = max( H − L, |H − Cp|, |L − Cp| )
    where H = current high, L = current low, Cp = previous close.

  2. For the first ATR (no prior ATR available), use the simple average:
    ATR_initial = (1/n) * sum(TR_i) for i = 1 to n
    (n is commonly 14)

  3. For each subsequent period, use the smoothed formula:
    ATR_today = (Previous_ATR * (n − 1) + TR_today) / n

Example (concise)

Given one day with H = 21.95, L = 20.22, previous close Cp = 21.51:
* H − L = 1.73
* |H − Cp| = 0.44
* |L − Cp| = 1.29
TR = max(1.73, 0.44, 1.29) = 1.73

If the sum of 14 TRs = 16.65, then:
ATR_initial = 16.65 / 14 ≈ 1.19

If ATR_previous = 1.19 and TR_today = 1.18, with n = 14:
ATR_today = (1.19*(14−1) + 1.18) / 14 ≈ 1.19

Practical uses

  • Position sizing: scale position size inversely with ATR to target a consistent dollar volatility per trade.
  • Stop placement (trailing stops): e.g., Chandelier Exit = highest high since entry − (ATR × multiplier). Common multipliers: 2–3 ATRs.
  • Trade signals: price moves more than 1×–2× ATR beyond recent closes can indicate breakouts, though ATR alone doesn’t indicate direction.

Limitations

  • ATR measures volatility, not trend direction — it won’t tell you whether prices will rise or fall.
  • Interpretation is relative: ATR readings should be compared to prior ATR values for the same asset, not used in isolation.
  • Spikes in ATR can reflect short-term noise (gaps, one-off events) and may produce misleading signals if not combined with other analysis.

Quick FAQs

Q: How do I read an ATR value?
A: ATR is in the same units as the asset’s price. An ATR of $1.19 means the asset’s typical daily range is about $1.19.

Q: What is a “good” ATR?
A: There is no universal “good” ATR—interpret it relative to the asset’s historical ATR. Sudden increases or decreases merit investigation.

Q: What default period is used?
A: 14 periods is standard, but traders may use shorter periods for sensitivity or longer periods for smoother signals.

Conclusion

ATR is a straightforward, widely used volatility metric. It’s most effective when combined with price analysis and other indicators to inform stop placement, position sizing, and breakout assessment.