Average True Range (ATR)

The Average True Range (ATR) is a technical analysis indicator that can help traders find the right trade, or the correct entry and exit point. This article introduces you to the ATR calculation and the ways in which it can be used when trading forex or stocks.

In detail, you will learn:

  • What Is The Average True Range (ATR)?
  • How Can The Average True Range (ATR) Help Investors?
  • Which Limitations Does The ATR Have?
  • Three Examples Of The Average True Range.

With this information, you will immediately be able to enhance your investing and decision making.

What Is The Average True Range (ATR)?

Definition: The ATR is a technical indicator. It uses a number range to interpret value based on past market movements via a formula. This calculation then allows you to understand what is going on and predict what will happen next.

This approach uses price action. It analyses what happens to the price of an asset to understand investor sentiment.

In the case of the ATR, the formula looks at the range of a period. The ATR wants to find out how far the price moved in a given period, and compare that to previous periods.

  • The ATR’s value is calculated by subtracting the current period’s low from its high.
  • If the previous period closed outside of the current period, the ATR uses the absolute value of the currents period’s high minus the previous period’s close (for rising periods) or the absolute value of the currents period’s low minus the previous period’s close (for falling periods).

In short, the ATR uses one of these four calculations depending on the initial conditions:

  1. Previous close within the range of the current period + Rising Period
    ATR = current high – current low
  2. Previous close within the range of the current period + Falling Period
    ATR = current high – current low
  3. Previous close outside the range of the current period + Rising Period
    ATR =current high – previous close
  4. Previous close within the range of the current period + Falling Period
    ATR =current low – previous close

The ATR repeats this calculation for as many periods as you want and then calculates the exponentially smoothed moving average of all results. The formula is reasonably simple.

If you are looking at an asset with a current value of £100 in a 1-hour chart and the ATR reads 0.2, you know that this asset has moved on average £0.2 up or down over the past periods. This information can help you make better predictions and trade more profitable binary options types.

ATR For the FTSE Index:

Average True Range FTSE

How Can The Average True Range (ATR) Help Traders?

The ATR is important for investors because it allows them to predict the range of a movement. When trading forex or stocks, the Average True Range can guide traders by giving an idea of the range within which the asset will move.

One particular use for the ATR value is in setting a stop loss or trailing stops. A vital tool for risk management, investors may have doubts over where to place a stop loss. Having an indicator which offers a suggested ‘working range’ for an asset, can be a big help in this regard.

Trailing stops are another popular choice among investors. Again, how far to set the stop away from the current price is not always an easy call. Using the true range, investors can set trailing stops with more confidence.

Away from more traditional forex and cfd trades, the indicator is also extremely valuable to binary options traders.

Let’s take a quick look at all binary options types and let’ see how the ATR can help you:

  • One touch options. One touch options define a target price. You have to predict whether the market will move in the right direction and whether it can reach the target price. If it touches the target price, you immediately win your option and get a higher payout than with a high/low option. The ATR can turn a high/low prediction into a one touch prediction by predicting the range of the movement.
  • Ladder options. Ladder options work just like high/low options but use a price other than the current market price as their point of reference. With this system, you can get payouts of up to 1,500 percent. The ATR helps you to predict whether the market has enough power to reach these target prices.
  • Boundary options. Boundary, or range, options define a price channel around the current market price. You win your option when the market leaves this price channel. They work just like a ladder option with two target prices in identical distance of the current market price. The ATR can help you predict whether the market can leave the price channel without requiring an additional prediction. This is the only trading style that allows you to win your option without having to predict the direction in which the market will move – thanks to the ATR.

As you can see from this list, the ATR can help many trades to improve their predictions. Nonetheless, the ATR also has some limitation. Let’s take a closer look at them.

Which Limitations Does The ATR Have?

The ATR can do a lot for you. Like all other indicators, it has limitations, though. When you use the ATR it is important to know these limitations and consider them in your trading. Let’s look at these limitations:

  • Range does not equal direction. If the ATR has a high value, the market might be unable to move far. When the market lacks direction, alternating upwards and downwards periods might keep the market in position.
  • Market environments change. As with many indicators the ATR can only tell you what happened in the recent past. It does not predict future price movement, or guarantee the range will hold . Important news events can create volatility. Likewise different times of the trading day might make the value less relevant.

Conclusion

The important point is to use the ATR to calculate the realistic reach of the market and then discount this value in a realistic way. Also keep an eye out for fundamental influences such as the release of big news or the end of trading day, which can alter the market environment significantly and render the ATR’s value obsolete.

Using the ATR to guide trailing stops and stop loss points is a helpful time saver, speeding up a decision that can often be agonised over for too long.