The Average True Range (ATR) is a technical analysis tool that measures the volatility of a stock or other financial instrument. The ATR was developed by J. Welles Wilder, Jr. and is designed to measure the average true range of price movement over a specified period of time.
The ATR is calculated by taking the highest of the following three values: the difference between the current high and the current low, the absolute value of the difference between the previous close and the current high, and the absolute value of the difference between the previous close and the current low. This value is then averaged over a specified period of time, typically 14 periods.
The resulting ATR value is plotted on a graph, with higher values indicating greater volatility and lower values indicating lower volatility. The ATR can be used to set stop-loss orders and take-profit orders, as well as to determine the size of a position in a trade. It can also be used to identify potential trend reversals and to confirm the strength of a trend.
Traders typically use the ATR in conjunction with other technical indicators and fundamental analysis to make informed trading decisions. For example, a trader may use the ATR along with moving averages and chart patterns to identify potential entry and exit points.
As an example, let’s consider the case of a hypothetical stock ABC. Suppose we use a 14-day period for the ATR. If the current ATR value is high, it may suggest that the stock is volatile and traders may want to set wider stop-loss orders to account for the increased volatility. Conversely, if the current ATR value is low, it may suggest that the stock is less volatile and traders may want to set tighter stop-loss orders. Traders may use this information along with other technical indicators and fundamental analysis to make informed trading decisions.
