Average True Range (ATR)
Average True Range (ATR) is an indicator which measures volatility. The indicator was developed by J. Welles Wilder and introduced in his book "New Concepts in Technical Trading Systems" in 1978.
The ATR indicator is calculated in the following way:
- Determine the true range which is the biggest of the following three values:
- Difference between the current high and current low;
- Absolute difference between the previous close price and the current high;
- Absolute difference between the previous close price and the current low.
- Calculate the average true range as a moving average (generally 14-periods) of the true ranges.
ATR measures volatility. The higher is the level of volatility, the higher is the ATR value, and vice versa - the lower is the level of volatility, the lower is the ATR value.
The indicator does not produce buy or sell signals by itself. It is rather a helping indicator.
The indicator values can be interpreted as follows. The bigger is the indicator value, the higher is the probability of a price reversal. The smaller is the indicator value, the weaker is the market trend.
ATR for Stops
The ATR indicator can be used to determine the best position for placing stop orders. Such stops will take into account the current market volatility.
To set stops with the ATR indicator, look at the indicator values and set stops from two to four times the ATR value.
For example, if you sell at the last candle and decide to use a two times ATR stop, then your stop will equal the current ATR value (107 pips) multiplied by 2 (214 pips).
When the volatility is high, wider stops should be used in order to avoid execution of stops by a random market movement. When the volatility is low, tighter stops should be used in order to have better protection for trades.
ATR for Trailing Stops
The ATR indicator can also be used for trailing stop orders. A famous trailing stop mechanism called the 'Chandelier' stop uses the ATR indicator to determine the amount of pips for a trailing stop.
The indicator can be downloaded from fxcodebase.
Another famous indicator based on ATR is Volty Channel Stop. It can also be downloaded from fxcodebase.
ATR for Support/Resistance Levels
When using support/resistance levels, it's possible that the market price breaks through a level but then returns to its previous level after some time. That is a false breakout occurs.
The ATR indicator can be used as a filter when trading with support/resistance levels. For example, if a resistance level is breached at 1.4000, then buy at 20% ATR above the breakout line. 20% ATR is calculated from the current ATR value. For example, if the current ATR value for EUR/USD is 0.0110 (110 pips), then 20% ATR is equal to 22 pips.
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