Average True Range (ATR)

The Average True Range (ATR) measures market volatility by calculating the average range of price movement. It's essential for setting stops, managing risk, and understanding market conditions.

What is ATR?

Definition

ATR:

• Volatility indicator
• Measures average range
• Non-directional
• Created by J. Welles Wilder

Purpose

Uses:

• Measure volatility
• Set stop losses
• Position sizing
• Filter trades

True Range Calculation

True Range Components

True Range is the GREATEST of:

1. Current High minus Current Low
2. |Current High minus Previous Close| (absolute value)
3. |Current Low minus Previous Close| (absolute value)

Why True Range?

Captures:

• Regular trading range
• Gap up moves
• Gap down moves
• Complete volatility picture

ATR Calculation

Formula:

• Average of True Range
• Over specified period
• Typically 14 periods
• Wilder smoothing: ATR = (prior ATR × 13 + current TR) ÷ 14

Standard Settings

Default Period

Classic:

• 14 periods
• Balanced view
• Most common

Shorter Periods

5-7 Periods:

• More responsive
• Recent volatility focus
• Quicker adjustments

Longer Periods

20-50 Periods:

• Smoother
• Broader volatility view
• Less reactive

Interpreting ATR

High ATR

Meaning:

• High volatility
• Large price swings
• Active market
• Wider stops needed

Low ATR

Meaning:

• Low volatility
• Small price swings
• Quiet market
• Tighter stops possible

Rising ATR

Indicates:

• Volatility increasing
• Potential trend starting
• Breakout possible

Falling ATR

Indicates:

• Volatility decreasing
• Trend weakening
• Consolidation possible

ATR for Stop Losses

Basic Method

Formula:

• Stop = Entry ± (ATR × Multiplier)
• Long: Entry - (ATR × 2)
• Short: Entry + (ATR × 2)

Common Multipliers

Conservative:

• 2-3 × ATR
• Wider stops
• Fewer stop-outs
• Smaller position for the same 1% risk

Aggressive:

• 1-1.5 × ATR
• Tighter stops
• More stop-outs
• Larger position for the same 1% risk

Example

Scenario:

• Entry: $50
• ATR: $1.50
• Multiplier: 2

Stop Calculation:

• Long stop: $50 - ($1.50 × 2) = $47
• Short stop: $50 + ($1.50 × 2) = $53

ATR for Position Sizing

Fixed Dollar Risk

Method:

1. Define risk amount (1% of a $50,000 account = $500)
2. Calculate stop distance (2 × ATR)
3. Position = Risk / Stop distance

Example:

• Risk: $500
• ATR: $2
• Stop: $4 (2 × ATR)
• Position: $500 / $4 = 125 shares

Volatility-Adjusted Sizing

Concept:

• Lower volatility = larger position
• Higher volatility = smaller position
• Consistent risk across trades

ATR for Trade Filters

Minimum Volatility

Filter:

• Require minimum ATR
• Avoid dead markets
• Enough movement potential

Maximum Volatility

Filter:

• Cap maximum ATR
• Avoid excessive risk
• Manageable stops

Volatility Expansion

Signal:

• ATR breaking above recent levels
• Potential breakout
• Increased opportunity

ATR-Based Trailing Stops

Chandelier Exit

Method:

• Highest high - (ATR × 3)
• Trails with new highs
• Gives room for volatility

ATR Trailing Stop

Method:

1. Set initial stop using ATR
2. Move stop as price moves
3. Use ATR multiple from current price
4. Only move in trade direction

Example

Long Trade:

• Entry: $50, ATR: $1
• Initial stop: $48 (2 ATR below)
• Price moves to $55
• New stop: $53 (2 ATR below $55)

ATR vs Other Volatility Measures

ATR vs Standard Deviation

ATR:

• Uses high/low/close
• Includes gaps
• More complete

Standard Deviation:

• Uses closing prices
• Misses intraday range
• Statistical measure

ATR vs Bollinger Bandwidth

ATR:

• Absolute value
• Dollar/pip amount
• For stops/sizing

Bandwidth:

• Relative measure
• Percentage
• For squeeze detection

ATR Across Markets

Stocks

Typical ATR:

• Varies by price
• Use percentage ATR
• Or normalize by price

Forex

Typical ATR:

• Measured in pips
• Major pairs: 50-100 pips
• Crosses: Higher

Futures

Typical ATR:

• Varies by contract
• Use for position sizing
• Consider margin

Common ATR Mistakes

Fixed Pip/Dollar Stops

Mistake: Using same stop regardless of volatility

Solution: ATR-based stops adapt

Ignoring ATR Changes

Mistake: Not adjusting as volatility changes

Solution: Recalculate stops regularly

Wrong Multiplier

Mistake: Too tight or too wide

Solution: Test appropriate multiplier

ATR for Direction

Mistake: Using ATR for entry direction

Reality: ATR is non-directional

ATR Best Practices

Combine with Direction

Approach:

• Use trend indicators for direction
• Use ATR for stop placement
• Separate roles

Consistent Application

Rule:

• Same multiplier for similar trades
• Consistent methodology
• Objective approach

Regular Review

Check:

• ATR levels changing?
• Market regime shifting?
• Adjust if needed

Key Takeaways

• ATR measures average volatility
• True Range includes gaps
• Use for stop loss placement
• Use for position sizing
• Higher ATR = wider stops
• Lower ATR = tighter stops
• Non-directional indicator
• Adapts to market conditions

What's Next?

Learn about volume-based indicators for analyzing market participation.

This article is for educational purposes only and does not constitute financial advice.