Average True Range (ATR) as a Technical Indicator for Measuring Volatility

Hello, all you wonderful people. Financial markets attract participants from all around the world due to their features such as high liquidity, diversity, and flexibility. The Forex market has a daily trading volume of trillions of dollars and is open 24 hours a day, 5 days a week. This allows traders from different time zones worldwide to trade whenever they want. Besides currency pairs, we can also trade stocks, commodities, indices, and cryptocurrencies. One of the most outstanding features is that we can open trades with small deposits for substantial positions, thanks to internet-connected devices and mobile applications. However, before that, we need to explore education and analysis tools, and learn about technical and fundamental analysis. Technical analysis is a popular choice for most. Here, indicators take the forefront, helping us avoid making emotional decisions. Through technical indicators, we can identify trends, measure volatility, and determine entry and exit points. The subject of our article today will be one of these technical indicators, the “Average True Range” (ATR) indicator.

What is the Average True Range (ATR)?

The Average True Range (ATR), used in financial markets, is a technical analysis indicator that measures the average magnitude of price movement of any asset over a specific period of time. ATR calculates the average value of price ranges that an asset (usually a stock, currency pair, or commodity) typically experiences during a day. This helps to determine how volatile prices are and any trend changes that may occur. By measuring price volatility within a specific time frame, it provides information about how much the asset’s price has moved. We commonly use the Average True Range (ATR) indicator to assess the intensity of price movements, determine volatility, and understand the extent of price fluctuations. This, in turn, allows us to manage our risks and make more informed trading decisions.

Calculation and Formula of Average True Range (ATR)

ATR, a volatility indicator, is calculated by measuring the difference between the highest and lowest prices of an asset during a previous period. This difference represents the true range of the asset’s price movement. ATR is then calculated by taking the exponential moving average of these true ranges. The formula commonly used to calculate ATR is as follows:

Firstly, one of the following three values is chosen for each day:

• The difference between the daily high and low prices.
• The difference between the previous day’s closing price and the daily high price.
• The difference between the previous day’s closing price and the daily low price.

These three selected values are calculated for each day. Then, these calculated values are used as a series, and average values are taken for any given period (e.g., the last 14 days):

                           ATR = TR1 + TR2 + TR3 + ... + TRn / n

In the final step, the calculated average value is used as the ATR value. In this formula, TR stands for the true range, and n represents the number of periods. ATR is commonly calculated over a time frame of 14 or 21 periods. A higher ATR signifies greater price variability in the asset, while a lower ATR indicates less price variability.

Trading with Average True Range (ATR)

We can also use ATR in a variety of ways, for example, to determine whether the price of an asset is in a trend or a period of consolidation, or to measure the movement of an asset’s price regardless of the direction of the trend. If ATR is rising and indicates that an asset’s price is in an uptrend, we might consider opening a long position at that time. Conversely, if ATR is falling and indicates that an asset’s price is in a downtrend, we might consider opening a short position. We enter a BUY order in the following situations:

1.  If the ATR value has remained low for an extended period and then starts to increase, it indicates that market volatility is rising. In this case, prices are more likely to rise and buying opportunities are created.
2. If an asset is in a clear uptrend and ATR values are also rising, it might be an indication that the trend could continue. Higher ATR values during price corrections suggest that the strength of the uptrend could be maintained.
3. When an asset approaches a specific support level and ATR values are increasing simultaneously, it suggests a higher probability of a reversal from that support level. In such cases, we might consider looking for buying opportunities.

ATR in cryptocurrency trading on the BTC/USD Chart

We place a SELL order in the following situations:

1. If the ATR value has remained low for an extended period and then experiences a significant increase, it suggests an increase in market volatility. In this scenario, the likelihood of prices falling might be higher, and we could identify potential selling opportunities.
2. If an asset is in a clear downtrend and ATR values are also rising, it might be an indication that the trend could weaken or a reversal might occur. This presents possible selling opportunities.
3. When an asset approaches a specific resistance level and ATR values are concurrently on the rise, it suggests a higher chance of the resistance level being broken. In such cases, selling opportunities might arise.

ATR can also be used to determine stop-loss and take-profit levels. When ATR is high, it indicates greater price variability in the asset. During such times, we might increase our stop-loss to take on more risk. Conversely, when ATR is low, it signifies lower price variability in the asset. In such cases, we can reduce the range of our stop-loss to take on less risk.

Don’t lose sight of the fact that. In the Forex market, along with the possibility of high gains, there are also high risks. Financial markets react very quickly to economic news, and indicators can produce incorrect signals in such cases. ATR is a powerful tool in technical analysis, but we should remember that ATR is not used solely for placing sell orders and should not be used in isolation. Therefore, by combining it with other technical analysis indicators, we can make more precise trading decisions. May your trades be prosperous!