What is Average True Range?

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.

Average true range is True Range (TR) smooth by an exponential moving average (EMA). True range is the high-low range for a day or session which is the greatest difference among the following.

1. Current high and low.
2. Absolute value of current high and previous close.
3. Absolute value of current low and previous close.

Which ever value is great, it is taken as true range.

Average true range is then calculated by taking an exponential moving average of TR for N periods. Wilder recommended a 14 period smoothing. In this case ATR is calculated by multiplying previous 14 periods ATR by 13, then adding current TR value to it and dividing the sum by 14. The periods can be hours, days, weeks or months; according to the trading style of the trader. The greater the ATR the greater the volatility.

Most common use of ATR is to generate entry signals by short-term traders. Buy signals are generated when prices cross next day open plus ATR and short signals are generated when prices cross next day open minus ATR. Many traders also use ATR for placing stop losses. But ATR only measures volatility, not trend changes, and thus the trader should use other indicators also.

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