What is Average True Range (ATR) trading strategy?

The Average True Range (ATR) is a technical indicator used to measure the price volatility of a financial asset over a specified time frame, typically 14 days.

ATR is calculated by averaging the true ranges over that period, providing a gauge of market volatility rather than indicating price direction. A higher ATR indicates increased volatility, while a lower ATR suggests reduced price fluctuations.

Key Points

1. The Average True Range is designed to measure the volatility of a market.

2. ATR can be used to help trader’s evaluation on setting stop-loss and take-profit limits and can be used in conjunction with a range of other technical indicators and trading strategies,

3. The Average True Range cannot predict the future, so traders will still need to do their own research.

Understanding Average True Range (ATR)

The Average True Range (ATR) is a technical analysis tool that measures market volatility by examining the full price range of an asset during a given period. It provides a numerical value representing the average of these true ranges over a specified time frame. Here's a closer look at its components and importance:

1. Components of ATR
ATR is derived from the largest of three values:
1) The difference between the current high and low,
2) The difference between the previous close and the current high, or
3) The difference between the previous close and the current low.

2. Significance of ATR in Trading
ATR's primary function is to provide traders with a clear understanding of the volatility associated with the asset they are trading. High ATR values indicate high volatility, suggesting larger price movements. Conversely, low ATR values denote low volatility, implying smaller price movements. This information is crucial for setting stop-loss orders and planning entry and exit points.

How to use ATR in trading

The Average True Range (ATR) can be a valuable tool for traders when developing their strategies. Here’s how it can be applied in different trading scenarios:

1. Day Trading
Day traders often use the ATR to gauge short-term volatility. By calculating the ATR over short time periods and adding it to the closing price, traders can better assess potential price movements in Day Trading.

2. Range Trading Strategy
ATR is useful for range trading by helping traders determine the market’s volatility and establish an appropriate trading range. Understanding the ATR can aid in identifying the boundaries of the range where trading is likely to be effective.

3. Breakout Strategy
Combining the ATR with a breakout strategy can be advantageous. The ATR helps traders identify when an asset breaks out of a low volatility zone, which often signals a significant price movement is imminent.

4. Momentum Trading
In momentum trading, the ATR can indicate increasing volatility, suggesting that the asset’s price might accelerate in either direction. Rising ATR values typically point to stronger momentum, whether bullish or bearish.

When considering shares, indices, forex (foreign exchange) and commodities for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss.

Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.