Average true range (ATR)

The average true range (ATR) is a technical indicator that is used within the financial markets to measure volatility. It analyses a range of asset prices within a given timeframe, taking into account any gaps in price action. The ATR indicator can be used for both short-term and long-term trading strategies, depending on how long you set the average time period for. Typically, it is set to a 14-day moving average. To measure more recent market volatility, you can set a shorter average of up to 10 periods, and for analysis of long-term volatility, you can set the average to over 20 periods. You can spread bet or trade CFDs on a wide range of financial assets while using technical indicators for analysis.

What is the ATR indicator?

The average true range indicator was developed by technical analyst J. Welles Wilder as a volatility indicator for the commodities market. In addition, it can applied to any financial market that shows volatility, in particular, stocks, currency pairs and indices.

The average true range is plotted on a trading chart as a single moving average line, which is calculated by the true ranges. This is usually on a candlestick chart, where volatility and price gaps are easy to spot. These types of charts are useful as traders can use the charts to identify entry and exit points for their positions.

The general rule is that a high ATR value indicates a higher level of volatility, whereas a low ATR value indicates a lower level of market volatility. Please note that the average true range does not represent or suggest market trends, only volatility and price gaps. As always, technical indicators tend to work well in conjunction with others; in this case, an indicator that could be used alongside the average true range to measure trend strength is the average directional index (ADX), also created by Wilder. This will ensure that all aspects of price action, trend and market volatility are covered for a comprehensive trading strategy.

Average true range vs standard deviation

Standard deviation is another technical analysis tool that aims to measure volatility and help traders to manage trading risk. The standard deviation describes the dispersion of a set of data around a moving average, typically calculated at 20 days, rather than a 14 day period. In a similar way to the average true range, a higher standard deviation indicates higher market volatility. However, although the average true range and standard deviation indicators share similarities, they also have several differences that set them apart, mainly in the way that they are calculated. This can make a difference in a moving market as to which indicator will be more useful. Read more about standard deviation here.

ATR in technical analysis

The average true range is a classic component of technical analysis, and it measures market volatility in a similar way to the relative strength index (RSI) and exponential moving average(EMA). Technical analysis is the study of price action and ignores all other aspects of fundamental analysis, such as external factors that can affect an asset’s price. By studying price charts continuously, short-term traders can assess where to plot profit targets, as well as execution types and stop-loss orders. The ATR can be used to generate buy and sell signals, depending on how volatile the market is, so a trader can decide whether to go long (buy signal) or short (sell signal) on a position.

How to calculate ATR

Before figuring out an average true range calculation, you need to calculate a series of true ranges first, which are based on historical price data. The true range of a given period is the greatest sum of the following:

Current high minus the previous close
Current low minus the previous close
Current high minus the current low

Once you have calculated the three true ranges, you can then move on to calculating the ATR formula.

Average true range formula

Average true range = (previous ATR x (n-1) + TR) / n

Where:

n = number of periods, so in most cases, this will be 14

TR = true range

Average true range strategy in trading

The average true range indicator was originally created for use within the commodities market, but has since expanded to a wide range of markets, which include forex trading and shares. The indicator can also be used for long-term and short-term trading strategies, such as position trading, day trading and scalping.

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ATR indicator in forex

Forex trading is the largest and most liquid financial market in the world, and traders can often encounter large losses from entering or exiting trades at the wrong time. If a trader uses the average true range appropriately in their strategy, they can assess current market volatility to see where they should place stop losses and limit orders. The greater the ATR reading is for a currency pair, a wider stop loss order should be used.

As shown in the example below, where there is an increase of market volatility on the candlestick graph for GBP/JPY, the ATR indicator also jumps sharply upwards. When there are price gaps, the moving average line appears smooth and stable.

ATR day trading

Day trading is a short-term strategy that aims to make small but frequent profits before closing out all positions at the end of the day. As soon as the financial markets open in the morning, including major stock exchanges, the ATR jumps from the level of the previous day’s close, indicating that market volatility is higher at the start of the day. Day traders can use the ATR to measure price action on a daily basis but also in the shorter term, such as for a one-minute timeframe.

Average true range futures

Futures or forward contracts are very popular derivative products to trade within the commodities market, as well as for forex pairs or stock indices. The average true range indicator can be used to approximate the size of the trade that traders should place for a specific commodity or asset. In a futures strategy, traders should assess the volatility of the market and consider their risk management options. They can also think about how prices can change depending on future trends, even if the indicator does not directly predict trend direction. This is why for some, the average true range tends to work well when used in conjunction with other trend following indicators.

ATR stop-loss calculator in risk management

When making trading decisions based on the average true range, it is important to consider your exit strategy. Many traders use stop loss orders, in particular a trailing stop, as a method to exit a trade if the markets move in an unfavourable direction to their position. However, if the market is moving in your favour, you can modify the exit point, where the trailing stop will follow behind the price to lock in profits.

For example, when analysing a price chart, traders often use the ATR to determine where to place a trailing stop loss. You can multiply the current ATR reading by two and place the stop loss at this level. If you are going long, you can place the stop loss below the entry price, and if you are going short, you can place the stop loss above the entry price. If the price is moving in the direction of potential profits, the stop loss will continue moving up or down until you close the position, once the trailing stop loss level is reached. This is known as a ‘chandelier exit’ strategy.

Download the ATR indicator

To set up the ATR indicator on our platform, you simply need to register for an account. This will give you automatic access to our demo account, you can practise trading risk-free with virtual funds using a wide range of indicators. However, with a live account, you will have full access to Next Generation, which has been voted the UK's best online trading platform, which includes stock charts, price projection tools and customisable charts. Learn more about our professional charting features here.

ATR indicator for MT4

The average true range indicator can also be displayed on the international trading platform, MetaTrader 4, which we host through our own software. Traders who are already familiar with the platform can setup the ATR MT4 indicator for similar use of measuring market volatility within the financial markets. Get started with an MT4 account now.

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