Average True Range (ATR) and its uses
Average true range (ATR) is an indicator of volatility of an asset (stock, futures, commodity etc)
that moves up and down as price moves.
It's an average of True Range (TR) values of an asset over the given time period in the past. ATR
for 14 days time period is normally used.
True range (TR) is arrived from
a) Current high minus the previous close or
b) Current low minus previous close or
c)Current high minus current low
whichever high (absolute values only, positive or negative doesn't matter) over a given time
frame. ATR is arrived from the average of TR values for the given period as following:
ATR (for 14 days) = TR for the 14 days/ 14
ATR value is not static as new ATR is arrived with the passage of each time period. For eg., for
one-minute chart a new ATR is calculated each minute. If it is daily time frame, a new ATR is
calculated each day. ATR indicates how much an asset moves, on average, over a given time
frame.
ATR is specific to the asset because the ATR is based on how much that asset moves and ATR
for one asset cannot be used for another asset.
ATR uses:
ATR provides a good estimation of how far we can expect the price to move and how long it
could take. ATR has multiple uses some of which are:
a) ATR for entering a trade (buy or sell)
A stock can be sold (going shot) when price goes up substantially equal to or more than ATR (or
when the price range for the day is larger than ATR and when the price is at the high of the day)
as the price is more likely to fall. Similarly, a buy trade may be initiated when price goes down
equal to or more than ATR (or when the price range for the day is larger than ATR and when the
price is at the low of the day)
b) ATR for fixing up target
Target can be fixed based on the ATR for the time period. For eg., day traders can use the one-
minute ATR to estimate how much the price could move in five or ten minutes. It may help
establish profit targets or stop loss orders. If the ATR of HDFC on the one-minute chart is 1.1,
then the price moves about Rs 1.10 per minute. If HDFC is bullish, one can buy and expect that
the price is likely to move by Rs 5.50 in 5 minutes. A trader can divide expected profit by the
ATR, and arrive at the minimum number of minutes for the price to reach profit target. If trader
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has a profit target of Rs 16.00 for HDFC it will take approximately 15 minutes to reach it (16/1.1=
15).
c) ATR for stop loss/trailing stop loss
ATR can be used as an effective tool for stop loss. While stop loss gives a way to exit a trade
reducing the risk, trailing stop loss locks in a profit as the price moves in your favour.
When a trade is entered a stop loss can be placed at a multiple of the ATR (ideal is 2) i.e., 2 X
ATR below the entry price if buying, or 2 x ATR above the entry price if shorting. Trader who
takes a long, continues to move the stop loss to 2 x ATR below the price when the price moves
favourably and it continues as long as prices moves favourably or till stop loss is hit when the
price drops to trailing stop loss level. Its same for the short trades when stop loss is moved down
at 2 X ATR as the price goes down.
For e.g., HDFC is bought at Rs 1950 and the ATR is 1.5 for 1 minute time frame, a stop loss at
Rs 1947 (2X ATR 1.5 = 3) can be placed. When the price goes up to 1956 stop loss can be
revised to 1953 if the ATR remains at 1.5 and when price further moves up to 1960 the stop loss
will be at 1957. If the price comes down and hits stop loss he will be still at profit of 7 points.
d) ATR for Renko
Renko size is normally taken at ATR for the time frame and it is easier to understand that each
brick movement indicates the price movement at ATR for the time frame used. Suppose, for
HDFC each brick can be taken equivalent to 1.5 in 1 minute time frame if brick size is selected at
ATR (when ATR is 1.5).
Limitations:
1. trade should not be entered only based on the ATR movement. It should be confirmed by any
other valid sell / buy signal.
2. ATR may move beyond ATR limit for the time period especially on trending days/ event days
when higher movement in ATR may be quite normal and caution may be exercised on these days
while using ATR .
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