What is Average True Range (ATR)?
Definition
Average True Range is a volatility indicator that measures the average range of price movement over a specified period, accounting for gaps. It is used for position sizing, stop-loss placement, and assessing market volatility.
Detailed Explanation
ATR was developed by J. Welles Wilder Jr. and measures volatility by calculating the true range for each period—the greatest of: current high minus current low, absolute value of current high minus previous close, or absolute value of current low minus previous close. The true range accounts for overnight gaps that the simple high-low range misses.
The ATR is typically calculated as a 14-period moving average of the true range. A rising ATR indicates increasing volatility, while a falling ATR indicates decreasing volatility. ATR does not indicate price direction—only the degree of price movement.
ATR is invaluable for position sizing and risk management. A common approach is to set stop-losses at 1.5-3x ATR below the entry price. Traders also use ATR to normalize position sizes—investing less in high-ATR (volatile) stocks and more in low-ATR (stable) stocks to maintain consistent risk per trade.
ATR-based trailing stops adjust automatically as volatility changes, widening during volatile periods and tightening during calm periods. The Chandelier Exit uses 3x ATR from the highest high as a trailing stop.
Formula
True Range = max(High - Low, |High - Previous Close|, |Low - Previous Close|); ATR = 14-period average of True RangeExample
A stock has a 14-day ATR of $3.50. A trader enters at $100 and places a stop-loss 2x ATR below at $93. The ATR-based stop adapts to the stock's actual volatility rather than using an arbitrary percentage.
Frequently Asked Questions
What does a high ATR mean?
How do I use ATR for stop-losses?
What ATR period should I use?
Related Terms
Volatility
Volatility measures the degree of variation in a stock's price over time. Higher volatility means larger and more frequent price swings, indicating greater uncertainty and risk. It is commonly expressed as the annualized standard deviation of returns.
Bollinger Bands
Bollinger Bands are a technical analysis tool consisting of a middle band (20-period SMA) and two outer bands set at two standard deviations above and below the middle band. They dynamically adjust to volatility, widening during volatile periods and narrowing during calm periods.
Stochastic Oscillator
The stochastic oscillator is a momentum indicator that compares a stock's closing price to its price range over a specified period. It oscillates between 0 and 100, identifying overbought conditions above 80 and oversold conditions below 20.
Standard Deviation
Standard deviation measures the dispersion of returns around the average return. In investing, it quantifies volatility—a higher standard deviation means returns vary more widely, indicating greater risk and uncertainty.
See It in Action
Disclaimer: The information on this page is provided for educational and informational purposes only and does not constitute investment advice. AI-generated analysis may contain errors or inaccuracies. Always conduct your own research and consult a qualified financial advisor before making investment decisions.
See Average True Range (ATR) in Action
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