Average True Range
The average true range (ATR) is a technical analysis indicator introduced by market technician J. Welles Wilder Jr. in his book New Concepts in Technical Trading Systems that measures market volatility by decomposing the entire range of an asset price for that period.
The true range indicator is taken as the greatest of the following: current high less the current low; the absolute value of the current high less the previous close; and the absolute value of the current low less the previous close. The ATR is then a moving average, generally using 14 days, of the true ranges.
Traders can use shorter periods than 14 days to generate more trading signals, while longer periods have a higher probability to generate fewer trading signals.
Definition: The Average True Range (ATR) is a technical analysis indicator introduced by market technician J. Welles Wilder Jr. in his book 'New Concepts in Technical Trading Systems.' It measures market volatility by decomposing the entire range of an asset's price over a specific period. ATR helps traders understand market volatility, aiding in better trading strategy formulation.
Origin: ATR was introduced by J. Welles Wilder Jr. in 1978, initially for analyzing volatility in commodity markets. Over time, ATR has been widely applied to various financial markets, including stocks, forex, and futures.
Categories and Characteristics: ATR has the following key characteristics:
- Simple Calculation: ATR is based on the maximum of three values: the current high minus the current low; the absolute value of the current high minus the previous close; the absolute value of the current low minus the previous close.
- Flexible Period: ATR typically uses a 14-day period, but traders can choose shorter or longer periods as needed. Shorter periods generate more trading signals, while longer periods generate fewer signals.
- Wide Applicability: ATR is applicable to various markets and time frames, helping traders assess market volatility.
Specific Cases:
- Case 1: Suppose a stock has a high of 100, a low of 90, and a previous close of 95 over the past 14 days. According to ATR calculation:
- Current high minus current low: 100 - 90 = 10
- Current high minus previous close (absolute value): 100 - 95 = 5
- Current low minus previous close (absolute value): 90 - 95 = 5
- Case 2: In the forex market, traders use ATR to set stop-loss points. For example, if a currency pair's ATR is 50 pips, a trader might set a stop-loss at 50 pips to protect their investment during high volatility.
Common Questions:
- Is ATR applicable to all markets?
Yes, ATR is applicable to various financial markets, including stocks, forex, and futures. - How to choose the ATR period?
The choice of ATR period depends on the trader's strategy. Shorter periods generate more trading signals, while longer periods generate fewer signals. - Can ATR predict market direction?
ATR is primarily used to measure market volatility, not to predict market direction. Traders should combine it with other technical indicators to formulate trading strategies.
