Uses for Average True Range

When traders talk about range, they are referring to a number that is the difference between the high price and low price of a time period. It does not include gaps and is a measure of the prices that have actually traded. Average True Range (ATR) is a technical indicator that measures volatility. To calculate ATR we must first define absolute value. To find absolute value, take the current high minus the previous close, and take the current low less the previous close.  Whichever is greatest is the true range. The ATR is an average of absolute ranges and is typically calculated using 14 days.

Simply, the higher the ATR, the more volatile a market is.

A simple range does not calculate gaps from open to close; absolute value does. Nowadays, volatility often jumps outside regular trading hours due to social media and unscheduled economic events. Though rare, gaps occur in futures markets, but they are prevalent in stocks and ETFs. For this reason, ATRs are a better measure and thus critical for projecting how far a market is apt to move. Many trading strategies use ATRs to project profit. A percentage of ATR is often used to determine stop loss once a position has been taken. In addition, a fraction of ATR is frequently used to set a trailing stop to lock in profits as a trade moves in your favor.

Setting profits targets and stops are integral parts of developing trade strategy.  Therefore, an ATR should be a vital part of your daily analytics.

The chart below shows the difference between a range and true range.

John Seguin, Market Taker Mentoring

Trader Education