Average True Range (ATR)

Introduction

The Average True Range (ATR) is a volatility indicator developed by J. Welles Wilder Jr. in 1978. Unlike many popular technical indicators, ATR does not attempt to predict trendTrendThe general direction in which a security or market is moving over time.Read full glossary entry → direction or momentum shifts. Instead, it serves one specific, crucial purpose: measuring the degree of price movement or volatility of an asset over a given time frame (typically 14 periods).

Why ATR Volatility Matters

In technical analysis, volatility is just as important as direction.

• Stop-Loss Calibration: ATR provides a mathematical baseline to set stops beyond normal noise.
• Asset Normalization: It allows you to compare volatility across different assets. A stock with an ATR of $0.50 behaves very differently from one with an ATR of $8.00.
• Position SizingPosition SizingThe size of a position within a portfolio or the dollar amount that a trader risks on a single trade, typically calculated as a percentage of total tr...Read full glossary entry →: By tying your trade volumeVolumeThe total number of shares, contracts, or units of a security traded during a specified time period.Read full glossary entry → to the ATR value, you normalize your dollar risk across all market conditions.

ATR Calculation Concept

To calculate the ATR, you must first find the True Range (TR) for each candle. The True Range is the greatest of the following three values:

1. Current High minus Current Low
2. Absolute value of Current High minus Previous Close
3. Absolute value of Current Low minus Previous Close

This ensures that any overnight price gaps are included in the volatility measurement. The ATR is then a smoothed moving average (usually a 14-period EMA) of these True Range values.

Volatility vs. Trend Direction

It is a common mistake to confuse ATR moves with trendTrendThe general direction in which a security or market is moving over time.Read full glossary entry → direction.

• Rallies on High Volatility: ATR rises because price swings are wide.
• Crashes on High Volatility: ATR rises because price falls rapidly, producing large daily ranges.
• Consolidations on Low Volatility: ATR declines because the price consolidates into small daily ranges.

Trading Applications

1. Volatility-Adjusted Stop Placement

To avoid getting stopped out by random market noise:

• Set your stop-loss at a multiple of the current ATR below your long entry (or above your short entry).
• Formula: Stop Loss = Entry Price - (Multiplier * ATR)
• The standard multiplier is 2x or 3x ATR.

2. Position Sizing

If your trading plan limits risk to $100 per trade:

1. Determine your entry and stop-loss using a 2x ATR. Let's say ATR is $2.00, so your stop distance is $4.00.
2. Calculate position size: Position Size = Total Risk ($100) / Stop Distance ($4.00) = 25 shares.
3. If ATR rises to $4.00, stop distance becomes $8.00, so Position Size = $100 / $8.00 = 12 shares.

Related Concepts

• Risk Management: Ties directly to position sizingPosition SizingThe size of a position within a portfolio or the dollar amount that a trader risks on a single trade, typically calculated as a percentage of total tr...Read full glossary entry → and capital preservation.
• Position Sizing: The method of adjusting share quantities based on stop-loss distance.
• Maximum DrawdownMaximum DrawdownThe largest peak-to-trough percentage decline in an account's equity curve before a new peak is achieved.Read full glossary entry →: High-volatility markets with large ATRs can lead to rapid drawdowns if position sizes are not correctly reduced.