The Average True Range (ATR) is a technical analysis indicator that measures the volatility of an asset’s price movement over a specified period of time. The researcher is J. Welles Wilder Jr. Traders and investors use ATR to determine the level of price volatility in a given security.
The ATR acts as the average of the true range values over a specified period of time. The true range is the maximum of the following:
- The difference between the current high and the current low
- The difference between the current high and the previous close
- The difference between the current low and the previous close
Knowing the Average True Range (ATR) can be beneficial for traders and investors for several reasons:
Risk Management: determine the size of stop-loss orders. A larger ATR suggests that the asset has a greater level of volatility. It means that a wider stop loss may be required to give the asset enough room to move without being stopped out.
Position Sizing: determine the appropriate position size for a trade. A larger ATR suggests that the asset is more volatile. Therefore, a smaller position size may be needed to manage risk.
Trend Identification: identify changes in the trend of an asset. An increase in the ATR suggests that the asset is becoming more volatile, which could be an indication that a trend change is imminent.
Breakout Confirmation: confirm the validity of a breakout. When an asset breaks out of a range or a trend, a surge in ATR can indicate that the breakout is genuine, and not just a false signal.
Overall, the ATR is a useful tool for traders and investors looking to manage risk, determine appropriate position sizes, identify potential trend changes, and confirm breakout signals.
