What is Average True Range?
Average True Range (ATR) is a technical indicator developed by J. Welles Wilder that measures market volatility. Unlike other indicators that focus on price direction, ATR focuses purely on volatility - how much an asset's price moves over a given period. It's calculated by taking the average of true ranges over a specified number of periods, typically 14 days.
How ATR is Calculated
Step 1: Calculate True Range
The True Range is the greatest of the following three values:
- Current High minus Current Low
- Absolute value of Current High minus Previous Close
- Absolute value of Current Low minus Previous Close
Step 2: Calculate Average True Range
ATR is typically calculated using a 14-period moving average of the True Range values:
ATR = (Previous ATR × 13 + Current TR) ÷ 14Sponsored Insight
How to Interpret ATR
High ATR Values
- • Indicates high volatility
- • Large price movements expected
- • Markets may be trending strongly
- • Higher risk, higher potential reward
Low ATR Values
- • Indicates low volatility
- • Smaller price movements expected
- • Markets may be consolidating
- • Lower risk, lower potential reward
Practical Applications of ATR
1. Position Sizing
Use ATR to determine appropriate position sizes based on volatility. Higher ATR suggests smaller positions to manage risk, while lower ATR allows for larger positions.
Example: If stock A has ATR of $5 and stock B has ATR of $2, you might trade twice the position size in stock B since it's less volatile.
2. Stop-Loss Placement
ATR helps set dynamic stop-losses that adapt to market volatility. A common approach is to set stop-losses at 1.5-2x the ATR from your entry point.
Formula: Stop-Loss = Entry Price ± (ATR × Multiplier)
3. Profit Targets
Similar to stop-losses, ATR can help set realistic profit targets. In trending markets, targets of 2-3x ATR are common, while in ranging markets, 1-1.5x ATR may be more appropriate.
4. Market Environment Assessment
Compare current ATR to historical ATR to understand if volatility is expanding or contracting. This helps determine appropriate trading strategies.
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ATR Trading Strategies
ATR Breakout Strategy
When price moves beyond the previous day's high or low by more than the current ATR, it may signal a breakout with strong momentum potential.
- • Entry: Price breaks previous high/low + ATR
- • Stop: ATR distance from entry
- • Target: 2-3x ATR from entry
ATR Position Sizing Formula
Calculate position size based on account risk and ATR:
Position Size = (Account Risk $) ÷ (ATR × Multiplier)Common ATR Mistakes to Avoid
Using ATR for Direction
ATR measures volatility, not direction. Don't use it to predict whether prices will go up or down.
Fixed ATR Multipliers
Using the same ATR multiplier across all markets ignores their unique characteristics. Adjust based on the asset's behavior.
Ignoring Market Context
ATR works differently in trending vs. ranging markets. Adapt your strategy accordingly.
Related Trading Concepts
Key Takeaways
- •ATR measures volatility, not price direction - use it for risk management, not trade signals
- •Higher ATR values indicate more volatile conditions requiring smaller position sizes
- •Use ATR multiples for dynamic stop-loss and profit target placement
- •ATR-based position sizing helps maintain consistent risk across different volatility environments
- •Compare current ATR to historical levels to gauge market conditions