Get to know ATR, the volatility analysis tool that traders need to use

Many traders may overlook a very important tool: ATR, or Average True Range. It’s an indicator that helps clearly measure price volatility. Unlike MACD or Moving Averages, which show trend direction, ATR measures the level of price fluctuation. This allows traders to set logical Stop Loss and Take Profit points that better protect their positions.

What is ATR? A Volatility Indicator, Not a Trend Indicator

If you’re still confused about what ATR is, simply understand that it indicates the volatility of the price—not whether the price will go up or down, but how much it’s swinging.

In this context, volatility refers to the uncertainty of price changes. The more violently the price swings, the higher the volatility. When the price is stable or consolidating, volatility is low.

ATR was developed by renowned engineer J. Welles Wilder, introduced in his book “New Concepts in Technical Trading Systems.” It’s an excellent indicator that many traders overlook because it doesn’t directly signal entry or exit points. Instead, it’s widely used to calculate appropriate Stop Loss and Take Profit levels based on risk levels.

How ATR Works by Measuring Price Changes Over Time

The operation of the Average True Range is straightforward. When the ATR line rises, it indicates strong price swings. Traders will see large candlesticks and continuous price movement on the chart. Often, a high ATR suggests significant market events or a battle between buyers and sellers.

Conversely, when ATR is low, the market consolidates or moves sideways with no major changes. Scalpers might need to wait during this period, as profits tend to be smaller.

Key signal: When ATR expands from low to high, it often indicates the price is leaving a range and entering a new phase, with a clear direction emerging quickly. When ATR contracts, the price may be preparing for a new breakout.

5 Main Benefits of Using ATR in Trading

1. Accurately Measures Price Volatility

ATR doesn’t just use the high and low of a single candle but considers the True Range, which includes gaps. This makes ATR more accurate than older methods. Traders can understand “how volatile today really is,” not just the open and close prices.

2. Helps Set Reasonable Stop Loss

Instead of randomly placing Stop Loss, traders use ATR to calculate a more logical level. For example, if ATR = 8.2 points, you might set your Stop Loss 8-10 points away from entry, depending on your risk appetite. This prevents being whipsawed out by normal volatility.

3. Guides Reasonable Take Profit Targets

Based on risk-reward principles, if your risk is small, your target should be small too; if volatility is high, your target can be larger. ATR helps traders set Take Profit levels based on actual market conditions rather than guesswork.

4. Identifies Breakout Opportunities

When ATR suddenly expands, it often signals a strong breakout. Traders may set alerts when ATR hits its highest point in the past 20-30 days to catch these breakouts.

5. Available for Free on Almost All Platforms

ATR is simple and doesn’t require complex calculations. Most trading platforms (TradingView, MetaTrader, etc.) include ATR as a standard indicator. Just add it to your chart and use.

ATR vs. Momentum: Understanding the Difference

Traders often confuse volatility (measured by ATR) with momentum. Let’s clarify:

Volatility (ATR) = Measures the amount of price change, regardless of direction. High ATR means large swings, whether up or down.

Momentum = Measures the speed and direction of price movement. If momentum is up, prices are accelerating upward; if down, prices are accelerating downward.

Real Market Examples:

• High ATR + Upward Momentum = Strong upward trend
• High ATR + Weakening Momentum = Market hesitation
• Low ATR + Weak Momentum = Consolidation or sideways movement

Candlestick analysis:

• Large candles with short wicks indicate high ATR but not necessarily a strong trend.
• Large candles with long wicks suggest high ATR + strong momentum, indicating a clear trend.

How to Use ATR to Set Stop Loss and Take Profit

Here’s a practical method most traders use:

Step 1: Check current ATR value on the chart, e.g., ATR14 = 8.5 points.

Step 2: Calculate Stop Loss and Take Profit:

• Long position:
  Stop Loss = Entry price - (ATR × 1 or 1.5)
  Take Profit = Entry price + (ATR × 2 or more)

• Short position:
  Stop Loss = Entry price + (ATR × 1 or 1.5)
  Take Profit = Entry price - (ATR × 2 or more)

Step 3: Set your Take Profit larger than Stop Loss based on risk-reward ratio. For example:

• Risk = ATR × 1
• Target = ATR × 2 (Risk-Reward 1:2)

Real Example:

• Entry: $100
• ATR = 5
• Stop Loss: $100 - $5 = $95
• Take Profit: $100 + $10 = $110
• Risk-Reward ratio = 1:2

Intraday Trading and ATR: Signals to Watch

Day traders should note that at market open, ATR often spikes sharply. This is crucial for intraday traders:

Morning (Market Open):

• ATR surges due to initial volatility.
• Price swings are large on 1-5 minute charts.
• Suitable for scalping but risky.
• If inexperienced, consider avoiding trades until volatility settles.

Midday:

• ATR tends to decrease as the market consolidates.
• Less movement, more dead time.
• If ATR remains high, the market is still uncertain.

Afternoon (Before Close):

• ATR may rise again if news hits or fall if market calms.
• Many intraday traders close positions before close to avoid gaps.

Key Signal:

• When ATR hits multi-week highs, it often signals a new trend beginning—an opportunity for traders.

How to Calculate ATR with Real Examples

Don’t think ATR is complicated. Here’s how to do it step-by-step:

True Range (TR) Calculation:

TR = Max of:

• (H - L)
• |H - C(previous)|
• |L - C(previous)|

Where:

• H = today’s high
• L = today’s low
• C(previous) = previous day’s close

Example:

• H = $49.32
• L = $48.08
• C(previous) = $49.93

Calculate:

• (H - L) = $1.24
• |H - C(previous)| = |$49.32 - $49.93| = $0.61
• |L - C(previous)| = |$48.08 - $49.93| = $1.85

TR = max($1.24, $0.61, $1.85) = $1.85

ATR Calculation:
Average of TR over the past 14 days (or chosen period).
If the sum of TR over 14 days is, say, 11.48, then ATR14 = 11.48 / 14 ≈ 0.82.

This indicates the average daily price change is about 0.82 points.

Common Mistakes Traders Make with ATR

Mistake 1: Thinking high ATR always means more profit potential.
Reality: High ATR indicates higher risk; profits depend on proper risk management.

Mistake 2: Using ATR solely to find entry points.
Reality: ATR measures volatility, not trend direction. Use with other indicators like MACD, RSI, or Moving Averages.

Mistake 3: Applying the same ATR period across all assets.
Reality: Different assets have different volatility profiles. Adjust ATR period accordingly (e.g., ATR7 for fast markets, ATR21 for slower).

Mistake 4: Forgetting to adjust or monitor ATR levels.
Reality: ATR can signal breakout or increased volatility, so set alerts accordingly.

Summary: ATR, a Trader’s True Friend

In simple terms, ATR is a tool that tells you how much the price is swinging. It doesn’t tell you whether the price will go up or down, but how much it’s changing—indicating risk and potential volatility. This helps traders set logical Stop Loss and Take Profit levels.

Successful traders don’t just look at trend direction; they also measure risk with ATR. Although less talked about than MACD or RSI, ATR’s effectiveness is undeniable.

When the market swings strongly, ATR rises; when it’s quiet, ATR falls. Use this signal along with other indicators to develop a more robust trading approach.

Frequently Asked Questions about ATR

Q: What is a good ATR value?
A: There’s no universal “good” value. It depends on the asset and timeframe. Higher ATR indicates more volatility. Comparing current ATR to past 50 days can reveal breakouts.

Q: What is the best ATR period?
A: Default is ATR14, designed by Wilder. Adjust based on your trading style:

• Swing trading: ATR14 or ATR21
• Day trading: ATR7
• Scalping: ATR5

Q: What if ATR is very low, near zero?
A: Low ATR indicates consolidation—little movement. Wait for volatility to pick up or a breakout.

Q: Can ATR be used with cryptocurrencies like Bitcoin?
A: Yes, but crypto is more volatile than stocks. Consider using longer periods like ATR21 or ATR28 to avoid whipsaws and false signals.