ATR: indicator you cannot do without

The Average True Range (ATR) Technical Indicator is an indicator of market volatility. It was introduced by Wells Wilder in the book “New Concepts in Technical Trading Systems ” and since then the indicator is used as a component of many other indicators and trading systems. This is a fairly popular indicator included in most programs for market analysis. Its main purpose is to set the correct Stop-Loss levels. This is the most effective method of setting stops, which is proved by statistics.

Average True Range also serves as a trend filter. It can be interpreted by the same rules as other volatility indicators. The principle of forecasting with the help of ATR is formulated as follows: the higher the indicator value, the higher the probability of a trend change; the lower its value, the weaker the direction of the trend. You will see a detailed overview of the indicator in today’s material.

Characteristics of the indicator

Platform: any
Currency pairs: Any
Timeframe: any from H1 and higher
Trading time: 24 hours
Type of indicator: oscillator
Recommended brokers: Roboforex, Alpari, XM

Calculation

The true range is the largest of the following three values:

the difference between the current high and low;
the difference between the previous closing price and the current high;
the difference between the previous closing price and the current minimum.

True Range = Max(High[1]-Low[1]; High[1] — Close[2]; Close[2]-Low[1])

The Average True Range indicator is the moving average of the true range values:

Average True Range = SMA(TR,N), where TR is a true range, N is an averaging period, SMA is simple moving average.

From the settings for the ATR indicator, only the averaging period is available, which is 14 by default.

Using ATR as a filter

ATR can be used as a trend filter. For this, the median line should be plotted on the ATR graph. When it breaks down, the most significant price movements occur. The indicator does not and can not have negative values and a certain median line, too. It is chosen manually, for each market separately. I advise putting a moving average with a long period on the ATR graph as a middle line. While ATR is below its moving average, traffic is insignificant and the market is calm. If the ATR breaks its average bottom-up trend begins. In addition, some traders recommend using the indicator on several TFs, for example, on H1 and D1. If their directions are correlated, and on a smaller TF indicator crossed its median line, the market revived. Once again, you need to adjust the ATR and the middle line for each market and each TF separately.

The ATR14 and MA100 work fine as a middle line for determining trading time for trading systems, based on the principle of a return to the average. Also very good is the Envelopes indicator (240), applied to the values of the ATR indicator. When ATR is below the Envelopes, volatility is small, and after a breakdown of the channel upward, sudden volatile movements are possible. Also, ATR is often used to determine the average length of a candle. For example, if the current ATR value is greater than, say, 20, or, conversely, less than 10, the trade entry is skipped. Here, everything is quite logical - if the current market has too small candles, then the potential for profit is small. If the candles are too large, then, most likely, there are some extreme events on the market, such as the release of important economic news. And, as we all know, during the news the market is rather unstable and the further direction of the movement of the instrument is hardly forecasted.

Using ATR to exit

ATR is often used to set an adaptive stop loss, both fixed and floating (trailing stop). The idea of setting stops based on volatility is what I personally like and I often use this option for trailing. As a rule, in order to calculate the required stop order size, the indicator value is multiplied by a certain constant, which depends on the theoretical duration of the future transaction. For hourly charts, for example, you can take a constant of 2-4. That is, for example, for a EURUSD transaction with ATR = 0.0062, we multiply 6.2 by the constant, for example, 3 and our stop is about 18 to 19 points.

Much more convenient (and I think, it will be quite correct and logical) to use ATR for trailing stop. In this case, the value of the trailing automatically adjusts to the current market volatility. For example, we entered a deal, accumulated a certain profit by position, and at a given distance the trail began to pull up to the price. The price, in turn, began a sharp move in the right direction. The trail is kept at a rather large distance, giving the market the opportunity to move on. Then the movement ends and the flat begins. ATR, accordingly, falls and our trail becomes shorter - the stop moves closer to the price. As you know, after periods of a strong trend there is flat, after which the price again starts its sharp movement, and not necessarily in our direction. In the case of a reversal after the flat period, we will lose just a little, as our stop is pulled close enough to the price. In the case of continuation, the events will be repeated again and again, until the activation of our stop order.

Conclusion

Without the use of the ATR indicator, it is difficult to imagine any serious expert advisor. This indicator is often used in the construction of automatic trading systems, especially when you need to build volatility filters or better adapt different values to the market. Also, the ATR indicator is indispensable wherever there is any measurement in points - instead of strictly setting, for example, the height of a candle of some candlestick pattern, it is much more convenient to specify these values as an ATR reading multiplied by a certain coefficient, and thus flexibly adjust your model for the current market volatility. Despite the widespread use of the ATR indicator in the algorithm, manual traders often underestimate the capabilities and usefulness of this indicator. I hope this article will convince many traders to take a closer look at such a useful indicator as ATR.

Regards, Michael

ForexTraderPortal.com