ATR indicator can measure the market volatility in an instant. Learn how this tool can help you in setting your stop-loss and profit target more effectively.
The market is always on the move, never sitting still. That's why keeping tabs on volatility is super important.
Volatility has a significant impact on how traders handle risk. Take, for instance, the way they set their stop-loss and profit targets.
But, you don't have to sweat trying to figure out volatility. There's an indicator called ATR (Average True Range) that does the job in real time.
What Is Average True Range (ATR)?
The Average True Range (ATR) was created by J. Welles Wilder, Jr. in his book "New Concepts in Technical Trading Systems". The ATR is an indicator that helps us understand market volatility.
Most traders use 14 days for ATR calculations, but you can use shorter ones if that suits your style. Although the ATR was designed for commodities markets, it has now found its way into various types of securities, including forex and stocks.
ATR does two key things: helps traders pinpoint the perfect time to jump into a trade and helps decide where to place a stop-loss and profit target for a savvy strategy.
The ATR Formula
The formula for determining ATR when you already have a prior ATR calculation is as follows:
- n = Quantity of periods
- TR = True Range
If you haven't previously calculated the ATR, you should use:
- TRi = Specific true range, such as the TR on the first day, then the second day, then the third day
- n = Quantity of periods
Formula to determine the True Range:
- High represents the highest price of the current period.
- Low represents the lowest price of the current period.
- Previous Close represents the closing price of the last period.
- Abs represents the absolute value function, ensuring positive values.
Calculating the ATR With 2 Simple Steps
We can determine the Average True Range (ATR) through these simple steps:
- Find the True Range (TR)
- Calculate the ATR
Let's say you've already calculated the 14-day Average True Range (ATR) for EUR/USD, and it's 60.0 pips. Now, looking at the price today, you'll have this information:
- Today's high: 1.07718
- Today's low: 1.06904
- Yesterday's close: 1.07477
To find the current true range, pick the largest value among these calculations:
- 1.07718 - 1.06904 = 81.4 pips
- 1.06904 - 1.07477 = -57.3 pips
- 1.07718 - 1.07477 = 24.1 pips
We'll go with 81.4 pips since it's the highest. You can use this to gauge the current 14-day ATR, which tells you how volatile the price might be. Here's how the formula works:
((60.0 x 13) 81.4) / 14 = 61.5 pips
Even though there's no major news, the price has already gone up by 81.4 pips today. That's 35% more than the average ATR (60.0 pips). You're receiving a buy signal from your strategy, but it's important to note that since the price has already made a significant move beyond the average, betting on further upward movement might not be the wisest decision. The odds are against you.
Given the substantial price increase and the fact that it's moved more than the average, it's more likely that the price will either stay within the established range or even drop. Buying when the price is near the top of the daily range, especially when it's well above the average, may not be a prudent move. Instead, selling or shorting could be a better option if a valid sell signal comes into play.
Inserting The ATR Indicator on MT4 and TradingView
Adding the ATR (Average True Range) indicator to your MT4 and TradingView charts is a straightforward process that can enhance your trading analysis. Here, we'll show you the steps to seamlessly incorporate this valuable indicator into your charting platforms.
ATR on MT4 Chart
- Open your MetaTrader 4 (MT4) trading platform.
- Select the chart where you want to add the ATR indicator.
- Click on "Insert" in the top menu.
- Choose "Indicators", select "Oscillators", and choose "Average True Range" from the list.
- A window will appear with settings for the ATR indicator. You can adjust the parameters as per your preferences.
- Click "OK," and the ATR indicator will be added to your chart.
ATR on TradingView
- Open your TradingView account and select the chart you want to work with.
- Locate the "Indicators" button at the top of the chart.
- A window will appear. Choose "technicals" and "indicators", then pick "Average True Range". You can also type in the search box "Average True Range" for a quicker process.
- The ATR with the default setting will be added below to your chart.
- To adjust the parameters of the ATR indicator, such as the period and color settings, click the settings on the top left of the indicator.
- The ATR settings window will appear. Now you can customize the period and color settings in the tab "inputs" and "style".
- Once you've set the parameters, click the OK button at the bottom of the settings window. Your preference settings will now be added to your TradingView chart.
How to Use The ATR in Intraday Trading?
You can use the ATR to determine stop loss, profit target, and adjusting risk in a trade. Here's how you do it.
Determine Stop Loss
The ATR can help you establish an appropriate stop-loss level for your intraday trades. By knowing the average price volatility of the asset you're trading, you can set a stop-loss that takes into account the typical price fluctuations.
For example, if the ATR value in the 15-minute time frame is 5 pips, you might consider placing your stop-loss 2 times the ATR value (e.g., 10 pips) away from your entry point. This way, you're giving your trade some room to breathe while also protecting it from excessive losses due to unexpected market movements.
Determine Profit Target
The ATR is also helpful in setting profit targets for intraday trading, especially the Daily ATR. It provides insights into the potential price range the asset can cover within a given time frame.
For instance, if the Daily ATR is 69 pips and the 1-hour ATR value is 11 pips, you might aim for a profit target of 2 or 3 times the ATR value (e.g., 22-33 pips) from your entry point. This approach allows you to capture potential price swings while locking in profits.
Adjusting Risk in a Trade
In intraday trading, risk management that is responsive to the market movement is crucial. The ATR can help you adjust your position size to align with the current market conditions and your risk tolerance.
If the ATR indicates higher volatility, you might consider reducing your position size to mitigate risk. Conversely, in lower volatility scenarios, you might increase your position size to optimize potential returns. By using the ATR as a guide, you can maintain consistent risk levels across different trades and adapt to changing market dynamics.
- What Does the ATR Tell You?
The Average True Range is like a gauge for how much an asset's price might fluctuate. Day traders use it along with other tools and tactics to decide when to enter and exit trades.
- Is ATR Good for Day Trading?
Yes, the Average True Range can be a valuable tool for day trading. You could use the Daily ATR to determine stop-loss and profit targets. It allows flexible risk management and confirms signals from other strategies.
- What is The Best Setting for The ATR?
The Average True Range typically uses 14 days but there isn't a single ATR period that can be considered the best or most profitable. It depends on your strategy, assets, and market conditions. Shorter periods (e.g., 5 days) react faster to price changes, while longer ones (e.g., 50 days) are smoother. Ultimately, choose the ATR setting that suits your trading style and needs.
In conclusion, the Average True Range (ATR) is a powerful and versatile tool that can benefit traders of all levels. When you take the time to become experts at using the ATR, you gain the confidence to navigate the ever-changing financial markets. For more information on volatility indicators, you may check out Beginner's Guide to Using Bollinger Bands for Swing Trading.