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ATR indicator: what is it and how does it work?
One of the most widely used indicators in trading is the Average True Range (ATR). If you have ever wondered what exactly the ATR is, this article is essential for you.
The Average True Range is a technical indicator that measures the volatility of a financial asset. This indicator shows, on average, how much the price of an asset varies over a given period of time, allowing traders to better understand market behavior.
The ATR is calculated by considering the current high and low levels, as well as the previous day's closing price, thus providing an accurate picture of the actual market volatility. This indicator is a key tool for traders and investors, helping them to manage risk and make informed decisions. Its main function is to identify periods of high and low volatility that can affect investment strategies.
Below we will tell you all about the ATR indicator.
What is the ATR indicator?
The ATR (Average True Range) indicator is a popular tool in technical analysis used to measure the volatility of an asset's price. Developed by J. Welles Wilder Jr., the ATR does not provide information about the direction of the trend, but about the strength of the volatility of the asset in question.
The ATR formula involves calculations based on the variations between the highs and lows of prices over a given period of time. The higher the ATR value, the greater the volatility of the asset, which can indicate larger and more unpredictable price movements.
How does the ATR indicator work?
The ATR (Average True Range) indicator is used in technical analysis to measure the volatility of an asset's price. It was developed by J. Welles Wilder Jr. and is calculated from the variations between highs, lows and closes of prices over a given period of time.
The formula for calculating the ATR consists of three main steps:
- True Range (TR): The True Range is the fundamental part of the ATR calculation and represents the largest difference between:
- The high and low of the current period.
- The high of the current period and the close of the previous period.
- The minimum of the current period and the close of the previous period.
The True Range is calculated as the greater of these three values.
- Average True Range (ATR): The ATR is an average of the True Range calculated over a given period. Initially, the ATR is calculated as a simple average of the True Range of the first few periods. The formula then adjusts the ATR in subsequent periods, taking into account the previous values.
- Interpretation: The ATR value is expressed in points or as a percentage of the current price of the asset. The higher the ATR value, the higher the volatility of the asset. This means that greater price fluctuations can be expected compared to assets with lower ATR values.
What is the most recommended calculation period for the ATR?
The most recommended calculation period for the ATR (Average True Range) indicator may vary depending on the trader's trading style and the asset in question. Here are some general considerations about ATR calculation periods:
- Short-term: For traders looking to capture short-term movements and intraday volatility, shorter calculation periods, such as 7 or 14 days, may be more appropriate. These shorter periods can provide a more sensitive and quicker view of changes in volatility.
- Medium-term: For traders trading with a more intermediate time horizon, calculation periods of about 20 to 30 days may be considered. These intervals can help smooth out short-term volatility somewhat and provide a more stable view of asset volatility.
- Longer-term: For long-term investors, longer calculation periods, such as 50 days or more, may be more appropriate. These longer periods can help capture broader trends in asset volatility over time.
How to use the ATR Indicator?
When trading cryptocurrencies, the ATR indicator can be used in 3 simple steps:
Step 1: Adapt the ATR to your trading timeframe.
For day traders trading on 5-minute charts, it is essential to adjust the period of the ATR to measure the volatility of the last few hours. For example, on a 1-hour time frame (with 12 5-minute candlesticks), you can calibrate the ATR to 12 periods to assess recent volatility or, if you prefer to assess the last 2 hours, calibrate it to 24 periods.
Step 2: Determine the size of the Stop Loss
Use the method proposed by Van K. Tharp, renowned author of books on risk management in trading. If you look at the ATR chart, a rising line indicates higher price volatility. The higher the line, the riskier the asset price. Adjust your stop loss according to this volatility.
Step 3: Set your profit target
If your trading system adopts a risk-return ratio of 1 to 3, multiply the size of your stop loss (calculated in the previous step) by three to set your profit target. For example, if the stop loss is 500 points from entry, your target should be 1,500 points to meet the 1:3 ratio.
In summary, adjust the ATR according to your trade, set the stop loss according to the volatility of the asset and set profit targets proportional to the risk taken.
It is worth combining the ATR indicator with other indicators such as the stochastic indicator.
How can I adjust the ATR for different assets?
Adjusting the Average True Range (ATR) indicator for different assets is essential to adapt your volatility analysis to the specific characteristics of each financial instrument. Here are some methods you can consider to adjust the ATR for different assets:
Adjust the period of the ATR
- More volatile assets: For more volatile assets, such as certain stocks or cryptocurrencies (like the BTC/USDT pair), it can be useful to increase the period of the ATR to better capture price swings.
- Less volatile assets: for less volatile assets, such as some Forex currency pairs, it may be desirable to reduce the ATR period to more accurately reflect lower volatility.
Relative comparison
- Compare the ATR between different assets to better understand their respective volatilities. This can help you select assets that match your risk tolerance and trading preferences.
Historical Calibration
- Analyze an asset's price history to determine the typical volatility range. Adjusts the ATR period based on this analysis to better reflect market conditions specific to that asset.
Experimentation and adjustments
- Test different ATR periods on historical asset data to identify which adjustment works best to capture volatility accurately and usefully for your trading strategies.
Continuous evaluation
- Asset volatility can change over time due to economic events, news or other circumstances. Be prepared to adjust the ATR period as needed to keep pace with these changes.
Conclusion
The ATR is commonly used in the creation of automated trading systems. It helps to build filters that take into account the volatility of the account or adapt different variables to the market. Manual traders often underestimate the advantages of the Average True Range indicator, but it can greatly help your trading by making it more accurate.
Keep learning 🤓
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- ATR indicator: what is it and how does it work?
- What is the ATR indicator?
- How does the ATR indicator work?
- What is the most recommended calculation period for the ATR?
- How to use the ATR Indicator?
- Step 1: Adapt the ATR to your trading timeframe.
- Step 2: Determine the size of the Stop Loss
- Step 3: Set your profit target
- How can I adjust the ATR for different assets?
- Conclusion
- Keep learning 🤓