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Average True Range (ATR)

Average true range (ATR) is a technical analysis indicator that evaluates market volatility by breaking down the whole range of an asset price for that period. It was first presented by market expert J. Welles Wilder Jr. in his book New Concepts in Technical Trading Systems. The largest of the current high less the current low, the absolute value of the current high less the previous close, and the absolute value of the current low less the previous close is considered to be the actual range indication. The ATR is then a moving average of the real ranges, often using a 14-day period.

How Average True Range Works (ATR)
As the range of each bar (or candlestick) increases, the ATR rises, indicating that market volatility is increasing. The strength of a price reversal would be indicated by a larger-than-usual increase in the ATR. Due to ATR's lack of direction, an increasing ATR may reflect either increasing selling or increasing purchasing pressure. Sharp price movements in any direction tend to increase the ATR, and ATR values that stay elevated for an extended period of time are quite unusual.
When the ATR is low, it means that the periods over which it was calculated had narrow fluctuations (quiet days). Due to the prolonged sideways price action, low ATR values are observed. If the ATR stays low for a while, it could be a sign that prices are consolidating before making a new move, or possibly reversing course.
When used as a stop-loss or entry-trigger, ATR alerts traders to potential shifts in volatility. Unlike fixed dollar-point or percentage stops, which cannot account for volatility, the ATR stop may adjust to areas of low volatility and high price volatility, such as consolidation zones, which can lead to unexpected price swings. The abnormal price swings can be caught by using a multiple of the ATR, such as 1.5 x ATR.

Calculation
Average True Range = (Previous ATR * (N-1) + TR) / N
ATR = Average True Range
N = number of periods (or bars, or candlesticks)
True Range = TR

The greatest of the following constitutes the True Range for the day
  • Daily range defined as highest point minus lowest point
  • Absolute value of today's high minus yesterday's close
  • Quantifying the difference between today's low and yesterday's closing

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