Applications of ATR

[RichardCox 10]

One of the most commonly used technical indicators that is implemented by experienced traders is the Average True Range, or ATR, which helps traders to measure volatility during a given time interval. The system was one of the many developed by J. Welles Wilder in the landmark technical analysis book “New Concepts in Technical Trading Systems” and as been a widely watched gauge of market activity ever since.

 

Calculations

 

Specifically, the ATR focuses on the range that develops for the time period you are watching and to do this certain calculations are required, and once these calculations are made, the highest value is taken:

 

1 - The interval high minus the interval low

2 - The absolute value of the interval high minus the previous close.

3 – The absolute value of the interval low minus the previous close.

 

As you can probably see, these calculations provide some variations, so that both bullish and bearish tradings can be factored in and the average true range is plotted finally as a 14 period moving average of the calculated ranges.

 

Market Applications and Volatility

 

The ATR can be applied to any of the major asset markets but is probably most famous amongst experienced forex traders as a means for setting stop losses and potential trend extension. Broadly speaking, the ATR measures volatility in the underlying price activity, so currency pairs with high ATR levels will be the most volatile (and, as a result, have the greatest potential for gains and losses). Lower ATR forex pairs (such as the EUR/CHF) display lower volatility levels.

 

Establishing Trading Parameters

 

So how can the ATR be used to establish trading parameters, such as entries, stop losses and profit targets? Since this can be one of (or perhaps the most) difficult part of any trading strategy, traders will do well do look into placing an ATR reading on their charts before new trades are made. Since the ATR essentially gives us a trading range that is dependent on volatility, trades that are based on pairs with higher ATR readings will require stop losses that exposure your trade to greater risk amounts. The positive is that since volatility works both ways, these pairs (GBP/JPY or AUD/NZD come to mind) will offer also the greatest potential for gains.

 

Stop Losses

 

Many new traders have difficulty establishing (and obeying) stop loss levels. In fact, one of the most commonly reported practices of new traders is to re-adjust their stop loss levels once they are close to being hit. But one of the best indications that the true market momentum is working against you can be seen when a currency pair violates the ATR in an unpredictable way. To help work against this, traders will often apply stops that are equal to the ATR, as any moves in excess of these levels suggests that deeper market activity is taking places.

 

Trade Entries and Profit Targets

 

The ATR can also be used on the other side of the equation, as traders look to set profit targets on anticipation of prices reaching the end of the daily range in the other direction. Once trades are “in the money” positions should be closed when prices near extreme territory, as this is a signal that momentum is likely to begin stalling. At the early stages of the trade plan, support and resistance levels start to become more important, as extended ATR readings that are posted when prices approach support (for long positions) or resistance (for short positions) can provide trades with excellent risk to reward ratios. The ATR is best suited for traders who like to keep things relatively simple and use techniques that are generally described as “classic” technical analysis.

[Tams 20]

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Oh My !

 

 

 

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