Average True Range (ATR) is a technical indicator commonly used to measure the volatility of a trading asset. ATR is not a predictive indicator, as its purpose is to indicate the volatility, the rate at which an asset moves. ATR moves up and down as the price moves become bigger or smaller. The indicator is useful for day traders as it helps them choose when to initiate a trade or where to place a stop-loss order.
How Average True Range Is Calculated
The calculation of the Average True Range involves the current period high/low as well as the previous close. Before we get to the Average True Range, a True Range first needs to be calculated. The True Range is in essential the maximum of the following (where ABS is the absolute value):
true range = max[(high – low), abs(high – previous close), abs (low – previous close)]
Once we have the True Range, the Average True Range is the Exponential Moving Average of it. ATR is plotted as a line below the main chart window. The most common look back period is 14 days, even though it’s up to the trader to determine which look back period suites his trading style the best. Click this link to access an economic calendar for your trading strategiesAverage True Range (ATR) | Indicator Series Click To Tweet
How Average True Range Is Interpreted
Without taking into account the price direction, ATR can be used to gauge the strength of a move. An authentic reversal should be accompanied by an increase in volatility. The same is true for a strong up or down move. Traders look at volatility as a confirmation of a trend. More volatility indicates that a lot of interest and pressure is causing the move, and therefore, the trend is authentic and backed by increased trading interest.
Volatility is especially important in case of a breakout or reversal. A breakout or reversal is confirmed if it’s followed by intense volatility.
In a trading range market, volatility is usually very low, as indicated by how narrow the price moves are. Daytraders use volatility implied by ATR to strategically calculate their entry and exit points.
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