Hello everybody, today I would like to introduce to you one of the best indicators in my opinion which is called Average True Range (ATR).
What is ATR and how it works?
Average true range (ATR) is a volatility indicator that shows how much an asset moves, on average, during a given time frame. Increased volatility in the market cause expanding ATR. Logically, low volatility results in low ATR. So with ATR we can indicate selling pressure or buying pressure. Sharp advance or decline is accompanied by high ATR and these moves are unlikely to be sustained for extended. Low ATR we can find during consolidations or
trend exhaustion. Low ATR can also indicate the possibility of a continuation move or reversal.
Calculation
ATR = (Previous ATR * (n - 1) + TR) / n
Where:
ATR = Average True Range
n = number of periods or bars
TR = True Range
Best way to use ATR
You can find many uses for this indicator on the internet. Each of them in my opinion is very good, but my favorite strategy is to use ATR to determine stop loss and take profit level. The best advantage is that ATR stop will adapt to sharp price moves or consolidation areas, which can trigger an abnormal price movement in either direction. So your Stop loss and take profit level will adapt to price movement. Stop-loss can be determined as 1 ATR or 1.5 ATR for example and your take profit level can be determined as 2 ATR or 3 ATR. These numbers by which you multiply ATR are mainly adjusted to the strategy you are using so the ratio may be different for each person.
You can also use ATR as a trailing stop loss. It simply enables you to move the exit point if the price is moving in your favor. Many day traders use the ATR to figure out where to put their trailing stop loss.
There are also other use-cases of ATR. You are not necessarily limited to adjusting size of your profit targets. You can go one step further and change your actual exit technique as well. For example, you would opt-in for trailing stop loss when ATR is above its top level. The aim would be to ride a potential trend for as long as possible. On the other hand, when the ATR is below its bottom level you would not use a trailing stop loss at all, but rather aim to exit as soon as possible using a much smaller profit target. This way you dynamically adjust your exit technique to the actual market's volatility using ATR indicator, but again you can go step further. You can start experimenting with different entry techniques as well. There are really quite a few different things you can do with the ATR indicator.
Hope you found today’s article helpful. If you want to learn more about trading follow me at @fizzonmyjayyce. Have a nice day :)