Average True Range or ATR is one popular volatility indicator which can be used by traders of all kinds. It was introduced by J. Welles Wilder in 1978 in his book “New Concepts in Technical Trading Systems”. Although the indicator was developed for commodity futures market, it can be used to trade all financial instruments including stocks and forex currencies.ATR.
It is a technical indicator that attempts to show the volatility of a given security. To calculate the average true range, you first calculate the true range by subtracting the day’s low value from the day’s high value, but substituting in the previous day’s close value if it was higher than the day’s high or lower than the day’s low. Then, the exponential moving average of the true range is calculated, typically over a 14 day period. The resulting value is said to be the average true value; a higher range indicates volume for the security will increase, while a lower range suggests that volume for the security will decrease.
More specifically, the average true range is the (moving) average of the true range for a given period. The true range is the greatest of the following:
# The difference between the current high and the current low
# The difference between the current high and the previous close
# The difference between the current low and the previous close
The average true range is then calculated by taking an average of the true ranges over a set number of previous periods. Care should be taken to use sufficient periods in the averaging process in order to obtain a suitable sample size, i.e. an average true range using only 3 periods would not provide a large enough sample to give you an accurate indication of the true range of the security’s price movement. A more useful period to use for the average true range would be 14.
Wilder originally developed the ATR for commodities but the indicator can also be used for stocks and indexes. Simply put, a stock experiencing a high level of volatility will have a higher ATR, and a low volatility stock will have a lower ATR.
Average True Range offers two basic signals:
* High values warn of market tops and bottoms
* Low values indicate ranging markets.