What is the Average True Range?

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 commodityCommodityA commodity refers to a good convertible into another product or service of more value through trade and commerce activities. It serves as an input or raw material for the manufacturing and production units.read more. However, even though it is used to predict trends, it does not indicate the direction of price movements.

Key Takeaways

  • 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 “[(Prior ATR x(n-1)) + Current TR]/n” where TR = ​max [(high − low), abs(high − previous close​), abs(low – previous close)].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. 

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 profitsTarget ProfitsThe estimated amount of profit that management intends to achieve during an accounting period is called target profit, and it is forecasted and revised on a regular basis as the business progresses.read more, 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 classesAsset ClassesAssets are classified into various classes based on their type, purpose, or the basis of return or markets. Fixed assets, equity (equity investments, equity-linked savings schemes), real estate, commodities (gold, silver, bronze), cash and cash equivalents, derivatives (equity, bonds, debt), and alternative investments such as hedge funds and bitcoins are examples.read more 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 [(high − low), abs(high − closeprev​), abs(low – closeprev​)]

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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.

Example

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 Cryptocurrencies Cryptocurrency refers to a technology that acts as a medium for facilitating the conduct of different financial transactions which are safe and secure. It is one of the tradable digital forms of money, allowing the person to send or receive the money from the other party without any help of the third party service.read morelike bitcoinBitcoinBitcoin is a digital currency that came into existence in January 2009, speculated to be created by Satoshi Nakamato, whose true identity is yet to be authenticated. It provides lower transaction fees than the traditional online payment systems, is controlled by the decentralized authority, and is not like government-issued currencies.read more 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.

This has been a Guide to the Average True Range (ATR) Indicator. We explain how the ATR indicator helps form a trading strategy, ATR bands, formula, and examples. You may also have a look at the following articles to learn more –

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.

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 “[(Prior ATR x(n-1)) + Current TR]/n”.

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.

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