What Is the Average True Range (ATR)?
Let me explain the Average True Range, or ATR, directly to you. It's a technical analysis indicator created by J. Welles Wilder Jr. in his book 'New Concepts in Technical Trading Systems.' ATR measures market volatility by breaking down the full range of an asset's price over a given period.
The true range is the greatest of these three: the current high minus the current low, the absolute value of the current high minus the previous close, or the absolute value of the current low minus the previous close. Then, ATR is a moving average of these true ranges, usually over 14 days.
You can adjust the period: shorter ones give more trading signals, longer ones fewer but potentially more reliable. ATR comes from a 14-day simple moving average of true ranges, started for commodities but now used across all securities. It shows the average price swing over your chosen period.
The Average True Range (ATR) Formula
Here's the formula if you have a previous ATR: (Previous ATR * (n - 1) + TR) / n, where n is the number of periods and TR is the true range.
Without a previous ATR, use: (1/n) * sum of TR_i from i=1 to n, where TR_i is each period's true range.
First, calculate true range: TR = Max[(H - L), |H - C_p|, |L - C_p|], with H as today's high, L as today's low, C_p as yesterday's close, and Max as the highest of those three.
How to Calculate the ATR
To calculate ATR, start by finding true range values for your security. The daily price range is high minus low, but true range accounts for gaps using the three terms I mentioned.
Take an example: Suppose XYZ stock hits $21.95 high, $20.22 low, and closed yesterday at $21.51. The values are $1.73 for H-L, $0.44 for |H - C_p|, $1.29 for |L - C_p|. The max is $1.73, so that's the TR.
For the initial ATR over 14 days without prior value, sum the TRs and divide by 14. Using sample data, the sum might be $16.65, so ATR is $16.65 / 14 ≈ $1.19 (close to $1.18 in rounded calcs).
For the next period, use the formula with previous ATR: Say previous is $1.18, new TR is $1.18, then ($1.18 * 13 + $1.18) / 14 = $1.18 again.
Key Takeaways on ATR Calculation
- ATR uses a 14-day average by default but can be adjusted.
- True range captures the largest movement, including overnight gaps.
- Initial calculation sums TRs and divides; subsequent ones smooth with the prior ATR.
What Does the ATR Tell You?
ATR, which Wilder made for commodities, works for stocks and indices too. A high ATR means high volatility; low ATR means the opposite for your period.
You can use it to enter or exit trades—it's great for measuring volatility from gaps or limit moves, not price direction. It's simple, just needs historical prices.
One way is the chandelier exit: Set a trailing stop below the highest high since entry, at a multiple of ATR. ATR also helps size positions in derivatives based on your risk tolerance and market volatility.
Example of How to Use the ATR
Imagine a five-day ATR starts at 1.41, and day six has TR of 1.09. Next ATR: (1.41 * 4 + 1.09) / 5 = 1.35. Repeat this over time.
Add ATR to the closing price for buy signals: If next day's price exceeds that, it might signal a volatility change and breakout. Signals are rare but often mark key points.
Limitations of the ATR
ATR has limits. It's subjective—no single value guarantees a trend reversal; compare to past readings for context.
It measures volatility only, not direction, so it can give mixed signals during pivots or turns. A spike in ATR against the trend might mislead you into thinking it's confirming, but it could signal a change.
How Do You Use ATR in Trading?
Use ATR with other tools to gauge volatility for entering/exiting trades or deciding buys.
How Do You Read ATR Values?
ATR is the average price range over your period. $1.18 means about $1.18 movement per day on average.
What Is a Good Average True Range?
It varies by asset. If normal is $1.18, deviations high or low warrant checking why before acting.
The Bottom Line
ATR indicates price volatility over a period, not trends. It's easy to calculate with price data and helps assess movement, but pair it with other indicators for full context.
