As a trading tool, the ATR indicator can be used to gauge how much volatility is present in a market. It can also help inform key trading decisions, such as the placement of stop-loss orders. However, just like any other technical analysis indicator, it does have some limitations and should be utilized as part of a wider strategy.
Originally developed by Wilder for the commodities market, the ATR can now be applied to Forex trading, stocks, and indices, as well as other assets. The indicator uses simple calculations to measure a security’s daily volatility. However, unlike some other volatility indicators, it does not rely on previous price data in order to provide its readings.
Instead, the ATR indicator reflects current and historical volatility by looking at the average of a given number of recent true ranges. Wilder found that simply looking at a day’s range was not sufficient to give an accurate reflection of a market’s current volatility. He, therefore, devised a system of using the average of a given number of previous true ranges, along with a multiplier, to determine the current ATR reading.
The multiplier represents how many standard deviations the ATR band sits above and below a middle line. Traders can adjust this value to suit their own risk tolerance and market conditions. A higher multiplier will result in the ATR bands being wider, which means prices would have to move a greater distance before triggering a buy or sell signal.
ATR can be applied to both trending and range-bound markets, with traders often utilizing the indicator alongside other technical indicators. This allows them to identify potential trade opportunities based on current and historical levels of volatility. It can also be helpful in determining the size of trades, with traders using ATR to find which assets are most volatile within their portfolio and adjusting the size of trades accordingly.
When a trading signal is triggered by ATR, it indicates that there has been a significant change in the price’s volatility level. This could indicate a breakout point, with the logic being that as soon as the price closes above a certain ATR value, a new trading opportunity will arise.
In addition to this, the ATR can be a useful tool in helping to bridge gaps and to help determine the best position size for a trade. This is particularly important when dealing with a volatile asset, where a tight stop loss may be triggered prematurely by any price movement.
If you’re interested in trying out ATR, why not start experimenting today on a free demo account? With AvaTrade, you can try your hand at ATR trading on over 1,000 global financial assets, including Forex trading, Commodities, Stocks, and Indices. You can even use our extensive library of trading indicators and technical analysis tools to help you perfect your ATR strategies before deploying them on the live market.