Average True Range (ATR) Indicator Explained

Average True Range (ATR) Indicator Explained
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The ATR is a much used and referenced indicator which can be a very useful tool for the retail trader. In this article we will cover the main points of what the Average True Range (ATR) indicator is, how it can be used to deal with market volatility and some of its limitations.

What Is The Average True Range (ATR) indicator?

The ATR is a technical trading volatility indicator. It moves up and down depending on how much the volatility (range) of the asset is changing. A higher ATR value represents increasing price volatility and a lower ATR value represents decreasing price volatility for a given time period.

In summary the larger the range of the candles are, the higher the ATR is going to be and vice versa. In the example below you can see how the ATR increased when the size (range) of the candles increased and then decreased as the candle ranges decreased.

ATR Increase Decrease Example
ATR Increase Decrease Example

You can download our FREE Candle Range indicator HERE

ATR Classification Table:

Let’s look at the classification of this indicator:

Indicator Classification Oscillator, Volatility
Leading / Lagging Lagging
MT4 Default or Custom Default

What Does The ATR Indicator Actually Show?

The ATR indicator only indicates price volatility; it can be in either direction upward or downwards hence why the absolute value is taken to calculate the ATR.

It is important to note that the ATR is not a trend indicator, it does not show you the direction of the trend and often will often even move in the opposite direction of the trend as can be seen below.

ATR Does Not Show The Direction Of The Trend Example
ATR Does Not Show The Direction Of The Trend Example

What Is The ATR Period and Time Frame?

The ATR indicator measures the average volatility of an asset for a particular timeframe over a set time period.

What does this mean? So first of all the timeframe: this just means that the ATR will show you a different value depending on the time frame you are looking at. This makes sense as an asset will always have more movement over a whole day than it would over a 1 hour period.

In the below screenshots you can see the ATR (14) for the Dax on the daily chart is 268 compared to the 39 for the hourly chart shown above.

ATR Value Depends On The Time Frame Example
ATR Value Depends On The Time Frame Example

Secondly, time period, this is the number of periods over which you will take the average. When you see the ATR indicator, this is the number in the brackets, eg ATR(14).

So in our chart of the DAX daily above, the ATR is showing us how much on average that market moved between its high and low each day over the last 14 days.

How Is The ATR Calculated?

To calculate the ATR, we simply need to find the range of each candle (the difference between the high and low) for the each candle in the period to be measured, add them all together and then divide by the period number.

To use the Dax example again, we have chosen an ATR of 14. So we look at each of the 14 daily candles and work out the range for each one by taking the absolute value (i.e. not a negative number) of the range.

ATR Calculation Example
ATR Calculation Example

We add all the ranges together and then divide by 14 which gives us the ATR(14) figure of 268.

ATR Calculation Chart Example
ATR Calculation Chart Example

That figure is then recalculated on an ongoing basis for each new candle which then forms the ATR indicator as seen.

The ATR Is An Oscillating Indicator, What Does That Mean?

The clue is in the name and the key feature of this indicator is that it oscillates. This basically means that it moves up and down in a cycle.

This makes sense as all markets follow cycles. When we say that, we are normally referring to the cycles of prices moving up and down in trends. However, the same is true for volatility.

The Law Of Volatility

A period of low volatility will be followed by a period of high volatility and vice versa. This is almost like an unwritten rule of markets.

How To Use The ATR Indicator

As An Indication Of A Potential Breakout

This follows on from the law of volatility above that a period of low volatility will be followed by a period of high volatility.

As such if the market has been in an extended period of low volatility – where the ATR has been downtrending for a long period of time then the longer this goes on the more likely it is that a reversal will occur in volatility.

If the market you are watching then breaks through a key area of support or resistance with an uptick in the ATR, the combination could signal a potentially strong period of price movement in the direction of the breakout.

This method works best for longer term volatility trends (weekly).

ATR As An Indication Of A Potential Breakout Chart Example
ATR As An Indication Of A Potential Breakout Chart Example

Using ATR To Set Up A Stop Loss

This is one of the most common uses for the ATR that traders use and is implemented in a few different ways. You would add it to your entry price as a stop for a sell order and subtract it from your entry as a stop for a buy order.

1.The entry +/- 1 times the ATR for short term trading especially scalping on currencies.

Using ATR To Set Up A Stop Loss Chart Example 1
Using ATR To Set Up A Stop Loss Chart Example 1

2.The entry +/-1 2 times the ATR for intraday trading.

Using ATR To Set Up A Stop Loss Chart Example 2
Using ATR To Set Up A Stop Loss Chart Example 2

3. As a % of the daily ATR. 10% for intraday trading up to 50%-100% for swing traders.

Using ATR To Set Up A Stop Loss Chart Example 3
Using ATR To Set Up A Stop Loss Chart Example 3

4. Adding or subtracting 1 times the ATR to a stop set on a resistance or support level to avoid getting stopped out at that level.

Using ATR To Set Up A Stop Loss Chart Example 4
Using ATR To Set Up A Stop Loss Chart Example 4

Point 4 is a very useful application of the ATR for traders. Stop placement is a key part of trading and can have a huge impact on your overall returns.

It is very common to set a stop loss just above or below the recent support or resistance and it is just as common to see that stop triggered just before the market then moves back in the direction you were hoping but without you aboard!

The ATR is a perfect and logical solution to this as the ATR indicates how volatile the market has been recently, it can be used as a guide for how much room you should leave for your stop.

In the examples above I used Risk To Reward Tool. You can download this MT4 Indicator for FREE HERE or click on the picture.  

ATR as a trailing stop:

Some people will also use the ATR value as a trailing stop. The logic for this is similar to the use as a single stop and can be a way to follow a trend without being stopped out by the normal movement (volatility) of that asset.

This is normally done by using a multiple of the ATR. The exact multiple will depend on the timescale of your trades and the trend you want to follow. Generally 2-3 for short term trends and 5-6 for longer term trends.

Note: you will need to change the trailing stop value each day as the ATR changes with each new session. To do this automatically, you will need an custom indicator to move the stop based on the ATR.

This is known as a Chandelier Stop and you will be able to find it by Googling that term.

Using The ATR To Signal Potential Reversals

Another possible application of the ATR is to signal potential reversals in the market. This generally happens when a market trend becomes overextended.

For example if the ATR for a period of time is 35 pips and the market has moved 160.3 pips or more in a single period then you may want to consider whether it is worth continuing in that direction and look out for signs of a potential reversal.

Using The ATR To Signal Potential Reversals Chart Example
Using The ATR To Signal Potential Reversals Chart Example

Limitations of the ATR Indicator

The ATR indicator shouldn’t be the only measure of technical analysis and should be used in conjunction with other technical analysis tools.

Although the ATR indicator does give some great insights into the markets it does have limitations:

  • The ATR only measures price volatility and not the direction of the asset’s price. This can result in mixed signals especially when trends are at turning points.
  • It is a lagging indicator and as such it only tells you how volatile the market has recently been and not what it will be on any day.

Summary Of The ATR Indicator

  • ATR is a smoothed moving average of volatility over a given time frame.
  • It can be used on forex, index, stock, cryptocurrency, and commodity markets.
  • A 14 and 20 ATR are the most common.
  • ATR can be used to indicate when to enter or exit the market and is helpful in setting up a stop loss or trailing stop loss.
  • An indicator that uses ATR as a trailing stop is known as a chandelier indicator.
  • It can be helpful in indicating market breakouts after extended periods of low volatility.
  • It can be an indicator to start looking for reversals if the range of the current period is much larger than the ATR.

Read More About Indicators

Learn more about Indicators here: https://www.nothardtrading.com/category/indicators/

Justina Nothard

Justina Nothard

Hi, I’m Justina Nothard, a retail investor trading Stock Index Futures.

I understand how hard it can be for the ordinary trader to learn the basics and find useful tools and practical information.

This is why I decided to create Nothard Trading to help you take control of your trading.

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