What is Average True Range (ATR)?

Average True Range (ATR) is a volatility indicator that measures the average range of price movement over a specified period. Unlike other volatility measures that focus on closing prices, ATR captures the full range of price action within each period, including gaps.

Developed by J. Welles Wilder Jr. in 1978, ATR has become a cornerstone of technical analysis and risk management systems.

Understanding True Range

Before calculating ATR, you need to understand True Range (TR), which is the greatest of:
1. Current High - Current Low
2. |Current High - Previous Close|
3. |Current Low - Previous Close|

True Range captures the largest price movement for that period, accounting for gaps between sessions.

ATR Calculation

ATR = Moving Average of True Range over N periods

Traditional calculation uses Wilder's smoothing:
ATR(today) = [(ATR(yesterday) × (N-1)) + TR(today)] / N

Where N is typically 14 periods (Wilder's original setting).

Modern implementations often use:
- Simple Moving Average (SMA)
- Exponential Moving Average (EMA)
- Hull Moving Average (HMA)

Interpreting ATR Values

High ATR indicates:
- Increased volatility
- Wider price swings
- Higher uncertainty
- Potential trend changes
- Increased risk

Low ATR suggests:
- Reduced volatility
- Consolidation phases
- Market equilibrium
- Lower risk periods
- Potential breakout setup

ATR is absolute, not relative—a $100 stock with ATR of 2 is less volatile (2%) than a $10 stock with ATR of 1 (10%).

Trading Applications

1. Position Sizing
   - Risk per trade = Account Risk % / (ATR × multiplier)
   - Higher ATR = smaller position size
   - Maintains consistent risk across different volatility regimes

2. Stop Loss Placement
   - Stop distance = ATR × multiplier (typically 1.5-3x)
   - Adapts to market volatility
   - Reduces noise-based stop-outs

3. Profit Target Setting
   - Target = Entry ± (ATR × reward ratio)
   - Risk-reward ratios based on volatility
   - Dynamic target adjustment

4. Trend Strength Assessment
   - Rising ATR + strong trend = momentum continuation
   - Falling ATR + weak trend = potential reversal
   - ATR divergence signals weakening moves

5. Breakout Validation
   - High ATR breakouts more likely to follow through
   - Low ATR breakouts often false signals
   - Volume + ATR confirmation

Advanced ATR Strategies

ATR Bands:
- Upper Band = Price + (ATR × multiplier)
- Lower Band = Price - (ATR × multiplier)
- Dynamic support/resistance levels

ATR Percentage:
- ATR% = (ATR / Close) × 100
- Normalizes ATR across different price levels
- Better for cross-asset comparison

ATR Squeeze:
- Identify periods of low volatility
- Anticipate volatility expansion
- Pre-position for breakout moves

Multi-Timeframe ATR:
- Compare daily, weekly, monthly ATR
- Understand volatility context
- Scale position sizing appropriately

ATR Limitations

1. Lagging Indicator
   ATR responds to volatility changes, doesn't predict them

2. No Direction Bias
   ATR measures magnitude, not direction of moves

3. Smoothing Effects
   Moving averages create lag in volatility detection

4. Market Regime Dependency
   ATR patterns vary across bull/bear/sideways markets

5. Outlier Sensitivity
   Single extreme moves can skew ATR for extended periods

ATR vs Other Volatility Measures

Standard Deviation:
- Uses closing prices only
- ATR captures intraday range
- ATR more practical for stop placement

Bollinger Bands:
- Based on standard deviation
- ATR provides absolute volatility measure
- Complementary rather than competing

VIX (Implied Volatility):
- Forward-looking volatility expectations
- ATR measures historical realized volatility
- Different time horizons and perspectives

Common ATR Settings

Period Selection:
- 14 periods (Wilder's original)
- 21 periods (monthly cycle)
- 10 periods (faster response)
- 50+ periods (long-term volatility)

Multipliers:
- 1.0x ATR: Tight stops, more whipsaws
- 2.0x ATR: Balanced approach
- 3.0x ATR: Loose stops, fewer false signals

Timeframes:
- Scalping: 1-5 minute charts
- Day trading: 15-60 minute charts
- Swing trading: Daily charts
- Position trading: Weekly/monthly charts

The MarketWizardry ATR Explorer

Our ATR calculator provides:
- Multiple moving average methods
- ATR percentile analysis
- Multi-timeframe ATR comparison
- Position sizing calculators
- Risk-adjusted stop levels
- Volatility regime classification

Try our free ATR Explorer tool: https://marketwizardry.org/atr-explorer.html

Related Reading:
- What is Value at Risk (VaR)? https://marketwizardry.org/blog/what-is-value-at-risk-var.html
- Understanding IQR Analysis: https://marketwizardry.org/blog/understanding-iqr-analysis.html
- What is Enterprise Value (EV)? https://marketwizardry.org/blog/what-is-enterprise-value-ev.html

ATR Best Practices

1. Adapt to Market Conditions
   - Increase multipliers in choppy markets
   - Decrease in trending markets
   - Adjust periods for different timeframes

2. Combine with Other Indicators
   - Trend direction (EMAs, MACD)
   - Momentum (RSI, Stochastic)
   - Volume confirmation

3. Regular Recalibration
   - Monitor ATR effectiveness
   - Adjust parameters based on performance
   - Account for changing market structure

4. Risk Management Integration
   - Link position size to ATR
   - Scale into positions based on volatility
   - Use ATR for portfolio heat adjustment

The Reality Check

ATR won't make you rich overnight, but it will help you stay in the game longer. It's a tool for managing the chaos, not eliminating it.

Markets are bipolar entities that swing between catatonic boredom and manic episodes. ATR helps you identify which mood the market is in and adjust your risk accordingly.

Use ATR as part of a comprehensive trading system. It's the speedometer for market volatility—useful information, but you still need to decide where you're driving and how fast you want to get there.

Remember: The market's job is to separate you from your money. ATR's job is to help you keep enough of it to fight another day.