ATR indicator: essence and calculation formula
ATR indicator – Average True Range. A technical analysis indicator that allows you to assess the volatility of volatility. The tool is not predictive and is most often used for preliminary analysis of the market situation or to confirm the signal of a trend indicator. ATR was developed in the late 70s of the last century and was originally intended for the futures stock markets – compared to stocks, futures showed significantly greater volatility in short periods of time. Later, the indicator became popular in the foreign exchange markets, after which it was included in the number of basic most trading platforms.
What is the ATR indicator
The author of the ATR indicator is D. Wilder, who also developed such well-known instruments as RSI and Parabolic SAR. In general terms, the ATR formula assumes:
- calculation of the difference between the current maximum and minimum prices;
- calculation of the difference between the closing price of the previous candlestick and the current maximum (modulo);
- calculation of the difference between the closing price of the previous candle and the current minimum (modulo).
From the obtained values, the maximum is selected, and the moving average is built on it. Visually, the ATR indicator is placed below the chart and is a line moving in a range. There is only one parameter in the settings – the period. The default is 14 (that is, the calculation is based on the last 14 candles). Increasing the period decreases the sensitivity of the ATR indicator, which is practiced at times of high volatility. A decrease in the period, on the contrary, increases the ATR’s sensitivity to price changes, which sometimes leads to an increase in the number of false signals.
The ATR indicator does not show the direction of price movement. Differences between the ATR direction and the price, unlike oscillators, are not regarded as divergence. The main purpose of setting ATR is to determine the stop placement points. To determine these levels, you need to go to short intervals (M1-M5-M15) and add the ATR value to the extremum of the closed candlestick (local extremum). Despite the fact that there is price noise at such intervals, it affects the price within the middle range, therefore it practically does not affect the formula for calculating the stop level. The exception is the influence on the quotes of market makers, who are capable of large capital to move prices beyond the middle range in the short term.
The ATR value “0.0081” with a period of 9 is read as the price volatility for the last 9 candles in a range of 81 points. For ATR with a period of 1, the value coincides with the difference between the High and Low of the last candlestick (the difference between the extreme values of the shadows).
The scope of the ATR volatility indicator:
- Setting stops. The most common options: at the level of the average ATR for the period (according to the volatility calculator), provided that the current value is less than the average. Another option is twice the ATR value (for long-term strategies with a deposit that can withstand a large drawdown). Stop length linked to ATR is determined by backtesting.
- Estimating the power reserve of the price. If the price has passed 70% or more of the average ATR, there will most likely be a reversal soon. ATR does not show the reversal level, but only speaks of its approaching. For example, the average daily ATR = 100 points. The price has passed 70 points since the beginning of the day (taking into account fluctuations in both directions within the range). So soon there will be a reversal and the beginning of a new trend. The take profit can be set according to the same principle: its current value is subtracted from the average ATR value. The result is the remaining power reserve of the price.
- Determination of the advisability of entering by trend strategies. If the current ATR value is less than 50% of the average, the market has weak activity and any price movement can hardly be interpreted as a trend (flat). Chaotic insignificant movements in both directions are possible, therefore, trades are not opened using trend strategies.
Also, ATR is almost an obligatory element of the risk management block of most trading advisors.
Output… The ATR indicator is an auxiliary tool that does not belong to any of the main groups (trend, forecast indicators and oscillators). It is advisable to use it in fundamental analysis trading for preliminary market assessment. When building a trading system and directly searching for points to enter the market, the indicator is rarely used. The main area of ATR application is setting stops: the higher the indicator value, the further the stop loss is set from the point of opening a deal.