The average true range (ATR) is a key indicator that traders use to measure market volatility. The ATR doesn’t predict price direction but rather helps traders understand the degree of price fluctuations over a specific period. Developed by J. Welles Wilder Jr. in his 1978 book, *New Concepts in Technical Trading Systems*, it's particularly useful in stock, futures, and forex trading.

In this article, we’ll answer some common questions about the topic: What does ATR mean? How to calculate it? And perhaps most importantly, how to use average true range effectively in your trading strategies?

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## What is ATR

The ATR focuses on providing a clearer picture of market volatility by measuring the range between high and low prices, as well as any gaps from one trading period to the next. Unlike some other indicators, the ATR doesn’t indicate the direction of price movements—it solely focuses on how much prices are moving, whether up or down.

This makes ATR particularly useful for traders who want to adjust their strategies in response to changing market conditions without relying on predictions about whether prices will rise or fall.

Instead, the ATR tells traders the extent of market activity, giving insight into whether the market is becoming more or less volatile. By evaluating this volatility, they can set appropriate stop-loss levels, position sizes, and trading strategies to manage risk effectively.

## The average true range formula

The foundational component of the ATR calculation is the true range (TR). It measures the range of price movement for a given period and is defined as the greatest of the following three values:

**Current high - current low:**The difference between the highest and lowest prices of the current trading period**Current high - previous close:**The absolute difference between the current high and the previous closing price, if the current high is greater**Current low - previous close:**The absolute difference between the current low and the previous closing price, if the current low is lower

Mathematically, this can be expressed as:

**True range (TR)=max(High−Low,∣ High−Previous Close ∣ ,∣ Low−Previous Close ∣)**

Once the true range values are calculated for each period, the ATR is determined by averaging these values over a specified number of periods, often referred to as “nnn periods.” This is done using a moving average, which smooths out the data to reflect a more consistent volatility measure.

The formula for calculating ATR is:

ATR=Moving Average of TR / n periods

The ATR uses a smoothing process, typically an exponential moving average (EMA), to calculate the average of the true range values. Unlike a simple moving average, the EMA gives more weight to recent observations, making it more responsive to recent price changes. This approach helps traders get a more accurate and up-to-date measure of volatility.

## Example: Calculating ATR for a stock over 3 days

To illustrate how to calculate the stock average true range using a shorter time frame, let’s walk through a hypothetical example using data for a stock over three days.

### 1. Gather stock data

Assume these are the high, low, and previous close prices for a stock over three days:

**Day 1:**High = $105, Low = $100, Previous close = $102**Day 2:**High = $108, Low = $102, Previous close = $105**Day 3:**High = $110, Low = $104, Previous close = $108

### 2. Calculate true range (TR) for each day

Using the true range formula:

TR=max(High−Low,∣ High−Previous Close ∣,∣ Low−Previous Close ∣)

Calculate TR for each day:

**Day 1**

TR calculation: max(105 - 100,

TR: 105 - 102

**Day 2**

TR calculation: max(108 - 102,

TR: 108 - 105

**Day 3**

TR calculation: max(110 - 104,

TR: 110 - 108

### 3. Calculate the ATR

**Sum the true range values:**

Sum of TR values=5+6+6= 17

**Calculate the average true range:**

ATR=Sum of TR values/ Number of Days=17 / 3=5.66

The ATR for this 3-day period is 5.66. This value reflects the average volatility of the stock over the specified ATR period.

## How to use ATR in trading

The average true range is a valuable tool for traders, providing insights into market volatility and helping in decision-making processes. Here’s how you can use it to enhance your trading strategies:

### Volatility analysis

By analyzing ATR values, traders can assess how much a stock or asset is likely to move within a given period. High ATR values indicate high volatility, while low ATR values suggest more stable conditions. Understanding this volatility helps traders adjust their strategies to fit the current market environment.

For instance, if ATR is high, you might anticipate larger price swings and adjust your trading strategy to accommodate the increased risk.

### ATR for stop-loss orders

The ATR can help you determine a stop-loss level that accounts for an asset’s volatility, reducing the risk of being stopped out prematurely due to normal price fluctuations.

For instance, if the ATR for a stock is 5 points and you want to set a stop-loss order, you could place it at a multiple of the ATR below your entry price. For a more conservative approach, you might set the stop-loss at 1.5 times the ATR below your entry price, which would be 7.5 points.

This approach accommodates volatility, allowing the stock to fluctuate within a reasonable range without triggering the stop-loss unnecessarily.

### ATR-based exit strategies

ATR is also useful in developing exit strategies, such as trailing stops and taking profits.

**Trailing stops:**You can use ATR to set trailing stops that adjust with the stock’s volatility. For example, if the ATR is 5 points, you might set a trailing stop 2 times the ATR (10 points) below the highest price achieved since entering the trade. As the price rises, the trailing stop moves up, locking in profits while giving the trade room to grow.**Taking profit:**ATR can help you determine optimal points for taking profits. By monitoring ATR, you can decide whether a stock has reached a volatility threshold that suggests it’s time to realize gains. For instance, if the ATR value indicates that price movements are becoming more erratic, it might be a good time to secure profits and exit the position.

### Day trading and long-term strategies

Traders use ATR in various trading strategies, from day trading to long-term investing:

**Day trading****:**Day traders use ATR to manage trades with short-term price movements. High ATR values might prompt day traders to set wider stops and profit targets, reflecting the increased volatility.**Long-term strategies:**For longer-term traders or investors, ATR helps in setting stop-loss levels and determining the volatility of an asset over extended periods. This can guide decisions about position sizing and risk management over the life of an investment.

## FAQs

**What is ATR in stocks****?**

ATR in stocks, or average true range, is a volatility indicator that measures the average range of price movements over a specified period. It does not indicate the direction of price movement but provides insights into the level of market volatility. By calculating ATR, traders can understand how much a stock typically moves within a given timeframe, helping them manage risk and set appropriate trading strategies.

**What does the average true range tell you?**

The average true range tells you how much an asset's price fluctuates over a specific period. It provides a measure of market volatility, showing how much the price of a stock or other asset has moved, on average, during the period analyzed. ATR helps traders evaluate the level of volatility and adjust their trading strategies, such as setting stop-loss orders and determining position sizes.

**How to read ATR value?**

Reading ATR values involves understanding the magnitude of price movements. A higher ATR value indicates higher volatility, meaning the asset experiences larger price swings. Conversely, a lower ATR value suggests lower volatility with smaller price movements. Traders use ATR to assess market conditions and make informed decisions about entry and exit points, as well as setting stop-loss orders.

**How to use ATR to take profit?**

ATR can be used to determine optimal points for taking profit by assessing the volatility of an asset. Traders may set profit-taking levels based on a multiple of the ATR value. For example, if the ATR is 5 points, setting a profit target at 2 times the ATR (10 points) above the entry price can align with the asset's volatility. This approach helps traders capture gains while accommodating the asset's typical price fluctuations.

**What is the ATR percentage indicator?**

The ATR percentage indicator expresses the Average True Range as a percentage of the asset's price. It provides a relative measure of volatility, allowing traders to compare the volatility of different assets or time periods on a standardized basis. To calculate the ATR percentage, divide the ATR value by the asset's current price and multiply by 100. This helps traders understand how volatility impacts price movements relative to the asset's price level.