Definition
The Average True Range (ATR) is a technical analysis indicator that measures market volatility by decomposing the entire range of an asset’s price for a given period. It factors in the highs, lows, and closing prices of a given period. It’s often used by traders to predict the likelihood of future price movements and set stop-loss orders.
Key Takeaways
- Average True Range (ATR) is a technical analysis indicator that measures market volatility by decomposing the entire range of an asset price for that period.
- Specifically, ATR measures the average of true price ranges over a specified period. The ‘true range’ considers the recent period’s high-low range, and any gap from the close of the previous period.
- Traders use ATR to assess the volatility of a financial instrument over time, which can help to determine the placement of stop orders or understand the behavior of certain stocks or commodities.
Importance
The Average True Range (ATR) is an important term in finance as it provides a comprehensive understanding of the volatility associated with a particular security or market index.
Essentially, ATR measures the level of price fluctuations, thereby assisting investors and traders to make informed decisions regarding their entry and exit points in the market.
Furthermore, it aides in evaluating the market trends and predicting future price movements.
A high ATR indicates a volatile market with wide price ranges or gaps, mientras que a low ATR reflects a more stable market.
Thus, the ATR is a critical tool that helps mitigate investment risks and optimize profitability in a constantly fluctuating financial market.
Explanation
The Average True Range (ATR) is primarily used as a gauge of market volatility. By gauging volatility, investors and traders can assess the level of risk associated with investing in a specific security or market. Since financial markets can fluctuate rapidly, the Average True Range serves as a tool that can provide insight on the degree of price volatility.
A high ATR indicates high volatility and, consequently, increased risk, while a low ATR suggests lower volatility and potentially lower risk. Apart from measuring the level of market volatility, the ATR is also used to determine the placement of stop-loss orders by traders. Essentially, a stop-loss order is an automatic instruction to buy or sell an asset once it reaches a certain price, aiming to limit an investor’s potential loss on a trade.
The ATR aids in determining a reasonable stop-loss level, because it takes into account market volatility—not just the asset’s price. That’s why it is deemed an essential tool in the successful execution of a sound money management strategy. The Average True Range can be employed in both trending and non-trending market conditions, thus offering flexibility to the user.
Examples of Average True Range
The Average True Range (ATR) is a technical analysis metric primarily used in trading to measure a market’s volatility. It involves calculating the average of true price ranges over a specific time period, such as 14-day period commonly. Here are three real-world examples:Stock Market Trading: For example, consider a stock such as Apple Inc. (AAPL), which perhaps has a 14-day ATR ofThis means the stock has, on average, moved $5 per day up or down over the last two weeks. Traders could use this information to gauge volatility, set stop-loss levels, or establish short-term trading strategies.
Commodities Trading: Assume a crude oil futures contract has an ATR of $5/barrel over a 14-day period. This statistic would imply that, on average, the price of a crude oil futures contract fluctuates up or down by $5 per day. Commodity traders could use this information to estimate the likelihood of sizable price movements and adjust their strategies accordingly.
Forex Market: Consider a currency pair such as EUR/USD has a 14-day ATR ofThis means, on average, this currency pair’s value goes up or down by 70 pips (0070) daily. Forex traders could use this knowledge to manage their positions, stop losses, or determine their risk per trade.
FAQs about Average True Range
What is Average True Range?
The Average True Range (ATR) is a technical analysis tool used to measure market volatility. It was developed by J. Welles Wilder, Jr. who introduced it in his book “New Concepts in Technical Trading Systems”. ATR is not a directional indicator, such as MACD or RSI, but rather a tool that portrays volatility based off the price range between the high and low.
How to calculate Average True Range?
The average true range is calculated by using a moving average of true range, usually over a period of 14 days or periods. The true range is the greatest of the following: the current high less the current low, the absolute value of the current high less the previous close, or the absolute value of the current low less the previous close.
What is Average True Range used for in trading?
The average true range is primarily used to measure volatility. It is commonly used in the calculation of stop orders in trading systems. The higher the average true range, the wider the stop order should be to allow for the volatility, and vice versa.
What does a high Average True Range value indicate?
A high ATR value indicates high market volatility. It shows that stock price values have varied greatly over a period of time. Traders might use a high ATR reading to open new positions in the direction of the trend, expecting higher price movement.
What does a low Average True Range value indicate?
A low ATR value indicates low market volatility. It shows that stock price values have not varied much in the past period. Traders might use a low ATR reading to exit trades, as it could suggest that the trend’s momentum may be weakening.
Related Entrepreneurship Terms
- Volatility
- Commodity Channel Index (CCI)
- Bollinger Bands
- Technical Analysis
- Relative Strength Index (RSI)
Sources for More Information
- Investopedia: A comprehensive resource for definitions of financial terms and tutorials on a variety of financial concepts, including the Average True Range.
- BabyPips: A website that provides simplified explanations of complex forex concepts, and it includes a section dedicated to indicators like the Average True Range.
- DailyFX: An online source for the forex market news and analysis. This resource includes educational information to help understand the use of Average True Range in trading.
- The Balance: This website provides expert advice on personal finance and money management, including definitions and explanations of terms like Average True Range.
