Average True Range (ATR)
A volatility indicator that measures the average range of price movement over a specified period.
Plain English Explanation
ATR measures volatility - how much an asset typically moves. It doesn't tell you direction, just the "size of the swings."
**What it tells you:**
- **High ATR:** Market is volatile, moving a lot
- **Low ATR:** Market is calm, not moving much
- **Rising ATR:** Volatility increasing (usually during trends)
- **Falling ATR:** Volatility decreasing (usually during consolidation)
**Practical uses:**
1. **Stop Loss Placement:** Use 1.5-2x ATR for stops to avoid noise
2. **Position Sizing:** Lower position size when ATR is high
3. **Breakout Confirmation:** Real breakouts usually have expanding ATR
4. **Profit Targets:** Use ATR multiples for realistic targets
**Example:** If stock XYZ has ATR of $2.50, setting a stop $0.50 away is too tight. It will get hit by normal price movement.
How It Works (Technical)
ATR calculates the true range (largest of: current high-low, current high-previous close, or current low-previous close) and averages it over a period (typically 14). This accounts for gaps and gives a true picture of volatility.
When It Works Best
- Setting stop losses that respect volatility
- Position sizing based on volatility
- Comparing volatility across different assets
- Identifying when to expect big moves
- Filtering out noise in trading signals
When It Fails
- Determining direction (ATR is directionless)
- After news events (sudden ATR spike)
- Comparing assets with different prices
- Very short-term trading (use shorter periods)
- As a standalone trading signal
Common Beginner Mistakes
- 1Using ATR to predict direction (it can't)
- 2Setting stops without considering ATR
- 3Using same ATR multiple for all assets/timeframes
- 4Ignoring ATR when it suddenly changes
- 5Not recalculating ATR regularly
Pro Tips
- Use ATR trailing stops: trail by 2x ATR from recent high/low
- Low ATR often precedes big moves (the calm before storm)
- Adjust position size inversely to ATR
- Compare current ATR to historical average
- Use ATR bands for dynamic support/resistance
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