Average True Range

What is Average True Range?

The Average True Range (ATR) is a key concept in trading. In simple terms, the ATR is a metric used by traders to measure the volatility of a particular security (like a stock, bond, or commodity). Volatility refers to the degree of variation in a security's price over time. The larger the changes in a security's price, the higher its volatility.

How Does Average True Range Work?

An important thing to understand about the ATR is that it doesn't provide an indication of price direction. Instead, it gives traders valuable information about how much a security's price is likely to move within a given time frame, based on historical price data. This is measured over a specific period, typically 14 days. The greater the ATR, the more dramatic the price swings are likely to be.

Why is Average True Range Important in Trading?

Average True Range is pivotal in trading because traders use this volatility measure to estimate the potential risk involved. High volatility implies a greater risk with potentially high reward. On the flip side, low volatility suggests lower risk but also less potential for big gains. Understanding the ATR can help traders to decide when to enter or exit a trade, set stop loss levels and take profit points.

Closer Look: Calculating the Average True Range

The ATR is typically calculated using the largest of the following three values: the current high minus the current low; the absolute value of the current high minus the previous close; or the absolute value of the current low minus the previous close. An average of these are then taken, most often over 14 periods for daily charts.

Using Average True Range in Day Trading

In day trading, the Average True Range can be a handy tool for gauging the level of volatility and setting stop-loss orders. By looking at the ATR, a trader can get a sense of how much a security's price could potentially move either up or down during the trading day. This can then aid them in deciding how much risk they are willing to take on a particular trade.