Understanding the Average True Range (ATR)
The Average True Range (ATR) is a volatility indicator developed by J. Welles Wilder. It measures market commitment by analyzing daily price ranges, helping traders identify:
- Trend strength: Expanding/contracting ranges signal market eagerness
- Potential reversals: Peaks often precede price tops/bottoms
- Ranging conditions: Low ATR values suggest consolidation phases
Unlike standard moving averages, Wilder's ATR uses a modified calculation method. The default period is 14 days, but this may require adjustment based on your trading strategy.
ATR Trading Signals and Interpretation
Key ATR Patterns to Watch For:
High ATR Values
- Warn of potential market reversals
- Often appear before major tops/bottoms
Low ATR Values
- Indicate sideways/ranging markets
- Suggest potential breakout opportunities
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Practical Example: Microsoft Corporation
- ATR peaks frequently preceded price extremes
- Low readings correlated with consolidation periods
- Early-stage declines showed elevated ATR values
ATR Formula Breakdown
True Range Calculation
TR = MAX of:
- Current High - Current Low
- |Current High - Previous Close|
- |Previous Close - Current Low|
ATR Computation
ATR = 14-day exponential moving average* of True Range
*Note: Wilder's EMA formula differs from standard calculations. Adjust periods using: ATR period = (n + 1) / 2
Optimizing ATR for Your Strategy
Recommended Settings
| Trading Style | Suggested Period | Adjustment Factor |
|----------------|------------------|-------------------|
| Short-term | 7-10 days | (n+1)/2 |
| Swing Trading | 14 days (default)| N/A |
| Position | 20-28 days | (n+1)/2 |
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Frequently Asked Questions
Q: How does ATR differ from standard volatility indicators?
A: Unlike basic range measurements, ATR accounts for gaps between sessions using true range calculations, providing more accurate volatility assessments.
Q: Can ATR predict exact reversal points?
A: While ATR peaks often precede reversals, they're best combined with price action analysis for confirmation—think of them as warning signs rather than precise signals.
Q: Why use 14 periods as the default setting?
A: Wilder's research found this timeframe effectively balances noise reduction with responsiveness to market changes across various asset classes.
Q: How should traders use ATR for stop-loss placement?
A: Many apply 1.5-2x the current ATR value from their entry point to account for normal volatility while avoiding premature exits.
Professional Application Tips
- Combine with trend indicators (e.g., ADX) to filter ATR signals
- Scale position sizes using ATR values—higher volatility = smaller positions
- Monitor divergences between price and ATR peaks for reversal clues
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