The Secret Mindset
The average true range (ATR) measures an asset’s volatility and helps traders set stop loss/profit targets. ATR can also be used as a filter and for trailing stop loss placement. ATR is not a unique value and should be used with a trading strategy.
Understanding and Using Average True Range (ATR) Indicator to Enhance Trading Strategy
Introduction
The Average True Range (ATR) is a powerful tool that can be used by traders to adapt to the ever-changing market environment. It is a useful indicator in measuring volatility, which is an important factor in trading decisions. ATR measures the price range of an asset – the higher the volatility, the higher the ATR. This article discusses the importance of ATR in trading, how to read the ATR indicator, how to trade with ATR, and using ATR as a trailing stop loss.
What is ATR?
ATR is one of the most useful indicators for traders because it helps them decide where to set a stop-loss or profit target, or whether to open a trade in the first place. It is measured as the greatest of any of the following 3 metrics: the value of the current high minus the low, the distance of the current high minus the previous close, and the distance of the current low minus the previous close.
Despite the fact that ATR is not so common among traders, this indicator can assist them in entering and exiting trades. ATR moves up and down as price movements become larger or smaller. A new ATR reading is calculated each time period passes. All the readings are plotted to form a continuous line, so traders can see how volatility has changed over time.
Using ATR to Filter Trades
First, ATR represents a range indicator for filtering out trades. If your trading strategy is based on huge market moves, ATR can filter out markets that are low in volatility. Even if you prefer calm, quiet markets, ATR will help you to filter out periods of times that you would prefer to avoid. However, it is important to remember that ATR does not measure market direction. By tracking the average true range, a trader cannot identify the prevailing trend on the market. The ATR only tracks the magnitude of range, so it has limited use for generating accurate trading signals.
Second, the ATR formula will assist you in setting profit targets. Knowing the average range is extremely useful since it allows the trader to estimate how much profit potential there is in the market. For example, there is no point looking for 200 pips of profit from a trade in a currency Pair, if the average true range for that market over the last 14 days is only 60 points. A simpler solution is to halve the 14-day ATR of the instrument and use this figure as your profit target. Thus, after entering a trade, you could set yourself a profit target of around 30 points.
How to Read ATR Indicator
ATR is useful in identifying low levels of volatility. It doesn’t tell the trader anything about market direction. Don’t get confused about its direction. If the ATR is going up on the chart, that doesn’t mean that the trend is up. A viable strategy would be to search for low volatility levels, in order to find a trade in the direction of the main trend.
How to Trade with ATR
The first thing we need to do is to identify where the low volatility actually is. Keep in mind that the low volatility itself is not enough for a new trend. This translates into the fact that the current trend has run out of steam, it doesn’t tell us that a new trend has begun. So, we must use the average true range in conjunction with other oscillators or price action. A smarter approach would be to wait for the average true range to exit from that level and confirm the volatility increase with a trend line breakout on the chart, or a rising Stochastic for example, or a divergence on the RSI or CCI, depending on your strategy.
Using ATR as a Trailing Stop Loss
A trailing stop loss is a way to exit a trade if the asset price moves against you but also enables you to move the exit point if the price is moving in your favor. Many day traders use the ATR to figure out where to put their trailing stop loss.
Here’s how it works: at the time of a trade, look at the current ATR reading. A rule of thumb is to multiply the ATR by two to determine a reasonable stop loss point. So if you’re buying a stock, you might place a stop loss at a level twice the ATR below the entry price. If you’re shorting a stock, you would place a stop loss at a level twice the ATR above the entry price.
Conclusion
In conclusion, the average true range is a great tool for traders to adapt to the ever-changing market environment. ATR assists traders in entering and exiting trades, setting profit targets, filtering trades, and using ATR as a trailing stop loss. By integrating ATR with other indicators, a trader can create a powerful tool to enhance their trading strategy.
