What is the Average True Range (ATR) and how to use it in trading

Basic Knowledge about ATR

When talking about technical indicators in trading, names like MACD, Moving Average, or Stochastic may be familiar. However, there is also an instrument called Average True Range designed to measure “price volatility,” which is a different dimension from trend analysis.

ATR (Average True Range) is an indicator that helps traders understand how prices move over different periods, without indicating whether prices will go up or down. Instead, it focuses on measuring the magnitude of those movements.

Who Developed ATR

This indicator was developed by J. Welles Wilder, who appeared in the book “New Concepts in Technical Trading Systems.” Although not as well-known as other indicators, ATR is widely used in risk management strategies, especially in calculating appropriate Stop Loss points.

How the Average True Range Works

How ATR works is by calculating the level of price volatility considering the High-Low range and gaps in the market. When ATR values increase, it indicates that prices are moving rapidly and with higher risk. Conversely, when ATR decreases, prices are more stable.

What does a high ATR level mean?

When the ATR line moves into the high zone, you’ll see candlesticks expand, indicating that prices are moving with strong momentum. This is a period to avoid rushing decisions.

What does a low ATR level mean?

On the other hand, when ATR drops, prices move less, candlesticks contract, and the ATR’s expansion decreases, indicating the market is entering a calm phase.

Main Benefits of Using ATR in Trading

1. Measure market volatility

Volatility (Volatility) is the phenomenon where prices fluctuate noticeably. ATR helps traders quantify the level of volatility to avoid being surprised by sudden movements.

2. Set appropriate Stop Loss and Take Profit levels

This is the most practical use of ATR. Traders can use ATR values to set protective levels. For example, if ATR is 50 points, a trader might set a Stop Loss 50 points away from entry price to align with market movements.

3. Identify trading opportunities

A very high ATR indicates the market is in a breakout phase that requires close monitoring. While a low ATR may signal a pause before a major move.

4. Easy and safe to use

There is no complexity in using ATR. Almost all trading platforms have this feature built-in, so you don’t need to calculate it yourself.

5. An essential component of advanced strategies

ATR is used alongside other techniques such as Momentum Trading, Position Sizing, and Trailing Stops to create more robust strategies.

Difference Between ATR and Momentum

Sometimes traders find it difficult to distinguish between these two indicators:

ATR (Volatility) - measures the size of price movements, whether up or down.

Momentum (Momentum) - measures the rate of acceleration in a specified direction, indicating whether the price is gaining or losing strength.

In practice, when ATR spikes high and momentum is strong, it indicates a solid uptrend. Candlesticks tend to be large with short wicks. However, if ATR is high but momentum is weak, you might see uncertain candles at the end of a move.

How to Use ATR for Day Trading

Day traders need to monitor rapid changes in volatility. At the market open, ATR often spikes immediately, especially on 1-5 minute timeframes.

During this period, prices may consolidate before establishing a trend. Traders should wait for ATR to stabilize before entering positions to ensure the timing is appropriate.

Basic ATR Calculation

Traditional ATR calculation uses a detailed formula:

Step 1 - Find True Range (TR)

TR = the greatest of:

• H - L (Highest - Lowest)
• |H - C previous| (Absolute value)
• |L - C previous| (Absolute value)

where H = High (Highest), L = Low (Lowest), C = Close (Closing price)

Step 2 - Calculate the average

Average the TR over a specified period, typically 14 days (ATR14)

Example: If the calculated TR ranges between 0.5 and 1.5 points, and the ATR is 0.82 points, it is considered a relatively high level.

Applying ATR in Real Markets

Case 1: High ATR

Signals that the market is in a breakout phase with many opportunities, but caution is needed because entries might be late.

Case 2: ATR contracts

Signals of contraction (Compression) often precede large expansions. Traders may be waiting for this breakout opportunity.

Setting Stop Loss & Take Profit Using ATR

Practical example:

• If ATR = 50 points
• Take Profit = current price + (50 × 1.5) = 75 points
• Stop Loss = current price - (50 × 1.5) = 75 points

Or simply:

• Take Profit = current price + ATR value
• Stop Loss = current price - ATR value

Common Questions About ATR

What should a good ATR be?

A good ATR is one that reflects volatility across multiple dimensions. It doesn’t need to be high; as long as it helps you set reasonable Stop Loss and Take Profit levels, it works well.

How to interpret ATR correctly?

• High ATR = high market volatility, rapid price movements
• Low ATR = low volatility, calm market

What does ATR tell traders?

ATR indicates whether the market has enough momentum to move. Regardless of direction, this information helps you adjust your strategy and risk management accordingly.

Summary

ATR is a tool that differs from other indicators because it does not indicate direction but measures the intensity of price movements. Traders who understand ATR can set reasonable risk management and reduce emotion-driven decisions.

Using ATR effectively requires understanding that it is only part of a complete strategy. Combining it with other indicators like Moving Average, RSI, or MACD can improve decision accuracy.