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Average True Range

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1 Average True Range (ATR) ATR is an indicator that measures volatility. If you apply it to your mother-in-law, it can help you avoid a lot of very difficult and uncomfortable situations. ATR is cool because it measures the greatest of three possible absolute values per period: 1. Current High Low 2. Current High Previous Close 3. Current Low Previous Close Because scenarios 2 and 3 need a gap to be greater than scenario 1, they are rarely applicable in the Forex market. Gaps are rare in the Forex market because it only closes once a week, rather than once a day like other markets (gaps are created when there is a major change in price and you see one candle open much higher or lower than the previous candle, creating a gap in between the candles). The Forex market also enjoys a higher degree of liquidity than other markets, making price gaps an infrequent occurrence. Most of the time in Forex, True Range will be comprised simply of the absolute value of: Current High Current Low. The standard setting for ATR is 14 periods. The ATR for the 14th period will be an average of the True Range for the last 14 periods. SUM (Absolute Value of High Low for last 14 periods) / 14 After that, the ATR is smoothed using the previous periods ATR value. The calculation looks like this: (Previous ATR x 13) + (Most Recent Absolute Value of High Low) / 14

If none of that made any sense to you, then its ok. You can still use ATR. As my college mentor once told me, You dont have to understand something in order to profit from using it. I think he was referring to women, but he could just have easily been talking about the ATR.

Using ATR: Because ATR is a measure of volatility, it is often used as a filter for mechanical systems. If your system does better in volatile conditions rather than quiet ones, you might say I only trade when ATR is greater than 18 pips on the 60min chart. Inversely, if your system does better in quiet markets, you might say I only trade when ATR is less than 18 pips on the 60min chart.

During a period of low volatility, you can also use the value of ATR to project upwards and/or downwards from current price (or another recent value of interest), and use that level as an entry for a breakout.

ATR can also be used to help determine Stops and Limits. You could set 2 x ATR as a stop and 3 x ATR as a limit for example.

What did we learn? ATR is a volatility based indicator The value of ATR can be used as a filter or as an entry/exit value in a system.