Average True Range (ATR) Indicator

Average True Range (ATR) is a technical analysis indicator used to measure market volatility. It was introduced by J. Welles Wilder Jr. in his book "New Concepts in Technical Trading Systems." The ATR does not indicate price direction; instead, it is designed to measure the degree of price movement (volatility) over a specified period.

How to Calculate the ATR:

1. True Range (TR): Calculate the True Range for each period. The True Range is the greatest of the following:

   • Current High minus the current Low.
   • Absolute value of the current High minus the previous Close.
   • Absolute value of the current Low minus the previous Close.

TR=max[(High−Low),∣High−Previous Close∣,∣Low−Previous Close 

1. Average True Range (ATR): The ATR is typically calculated using a 14-period exponential moving average of the True Range values.

   

   
   

   
   

   Where:

   • $ATR_{t}$ is the current ATR.
   • $ATR_{t-1}$ is the previous ATR.
   • $TR_{t}$ is the current True Range.
   • $n$ is the number of periods (commonly 14).

Example Calculation:

1. Calculate the True Range for each period.
2. Compute the initial 14-period ATR:
   • Sum the first 14 TR values and divide by 14.
3. Subsequent ATR values:
   • Use the formula to smooth the ATR with each new period's TR.

Application in Trading:

• Volatility Measurement: Higher ATR values indicate higher volatility, while lower values suggest lower volatility.
• Stop-Loss Placement: Traders often use the ATR to set stop-loss levels. For instance, a stop-loss might be set at a multiple of the ATR below or above the entry price.
• Position Sizing: ATR can help in determining position sizes to manage risk. Higher volatility might mean smaller positions, while lower volatility could allow for larger positions.