Table of contents:
- 1 What is the ATR indicator? Definition and explanation
- 1.1 Where can you find the Average True Range Indicator (ATR) in Metatrader?
- 1.2 ATR: Consider different time units
- 1.3 How do we use the Average True Range?
- 1.4 What do I do with the average range information on an asset?
- 1.5 ATR for stop loss calculation: This is how it works
- 1.6 Create a trading strategy with the ATR
- 1.7 ATR Trading Strategy by J. Welles Wilder
- 1.8 Conclusion:
The ATR indicator (Average True Range) can help a trader enormously in stop management as well as in the trading strategy. Here you learn how you can use it yourself to improve your trading.
Among the many and sometimes unnecessary trading indicators that are generally available to a trader, the ATR indicator (Average True Range) is one of the few that we consider.
What it is, how you can use it and where to find it, you will learn in the rest of this article.
We start with a short definition.
What is the ATR indicator? Definition and explanation
ATR stands for “Average True Range”, which translates as “average true range”. The ATR is a technical analysis indicator that measures market volatility by measuring the total range of an asset price (stock, Forex, etc). for that period.
Specifically, the ATR is a measure of volatility introduced by market technician J. Welles Wilder Jr. in his book “New Concepts in Technical Trading Systems”.
Volatility, in turn, is a statistical measure of the dispersion of returns for a particular security or market index. In most cases, the higher the volatility, the riskier the security or investment.
Volatility is often measured either as a standard deviation or as a variance between returns on the same security or market index. We also refer to volatility in general as the range of fluctuation.
For us traders, it is important to know the fluctuation margin of an asset such as Forex or stock in order to properly manage risk. For example, we would choose a different position size for Bitcoin than for the DAX, because the volatility in the crypto currencies is still very high and sometimes “unpredictable”.
The ATR indicator helps us to get an overview of this trading range of each asset with a few clicks.
As you will see later, we can use this specifically in risk management but also in a trading strategy.
Where can you find the Average True Range Indicator (ATR) in Metatrader?
The Metatrader is one of the most popular trading platforms among day traders and is offered by many brokers for free.
Here I show you where you can find the ATR indicator in MT4 and which parameters you can choose.
Step 1: Go in the menu of the Metatrader software on “Insert”.
Step 2: Go in the submenu then on “Indicators” and then on “Oscillators”.
Step 3: Click there on “Average True Range”. A pop-up will open in your chart window.
Step 4: Within the pop-up window you can now set the parameters of the ATR indicator.
When selecting parameters, the value “Period: 50” is often preset. This means that the average trading range of the last 50 candles is considered, which is sufficient in my opinion. We do not edit other values or visualization settings.
Once we have set the parameters, an indicator image with a blue line appears below the chart image.
This line shows you the average trading range for the selected time unit on the respective date.
You can see the value at the bottom left corner of the chart (not included in the above image), but you can also place a horizontal line from the MT4 tools at any position.
In the above chart, we look at the USDCAD 15-minute chart and get an ATR value of 0.0004. This means that the average trading range of the last 50 15-min candles in this forex pair is 4 pips.
ATR: Consider different time units
If we want to interpret an ATR value and use it for our trading, we have to look at it in different time units.
For example, the ART value in M15 is different from the ART value in H4. The larger the time unit, the larger the ATR must become.
If we stick to our above example, we have an ATR value of 0.0019, i.e. 19 pips, in the H4 of USDCAD when looking at the last 50 candles.
Often we only look at the values in D1, the daily chart, where one candle represents a complete trading day.
Why we do this you will find out in the next section.
How do we use the Average True Range?
Now that you know how the ATR indicator works, let’s look at the possibilities it offers.
The question a beginner might ask himself is:
What do I do with the average range information on an asset?
For us as new traders, it is a way to optimize our stop management as part of risk management. This means that we use the ATR to exit a trade.
If you would like to learn more about entering a trade and how we turn news into trades, then take a look at our free Newstrading Webinar.
Some traders also use the ATR for strategy building, i.e. the entry. We will also take a look at that.
ATR for stop loss calculation: This is how it works
Fortunately, most traders work with stop loss. Many place it above a resistance (for short trades) or below a support (for long trades).
Many big boys know these liquid zones and can provide stop fishing.
With the Average True Range you can use a different concept for your stop management. We proceed as follows:
- Determine the ATR in the D1 (daily chart) of the respective asset you want to trade.
- Determine 1 or 2 times the ATR as the distance to the purchase price.
- Place your Stop Loss there.
You can check this again using the following chart.
We have determined an ATR of 51 pips here in D1 (attention, you can see the H4!).
The buy price is the current price at 1.3195 and we go long. The SL should be 2 times the ATR (102 pips). 1.3195 – 102 = 1.3093. That is where the SL is placed.
This procedure is especially popular with daytraders and swing bikers, because under normal conditions (market noise) the stop is not reached so quickly.
Especially in the Forex market, where we find high liquidity and many different market participants, prices often go trendy and rarely with momentum.
It is important that the trader does not let this sometimes wider trading range lead to increased risk, which is why he must adjust the position size to this stop loss.
Create a trading strategy with the ATR
We presented the possibility of how Average True Range can help you with stop management.
Now we look at what potential trading strategies can be created with the help of the ATR indicator.
As we know, the ATR indicator shows us the average trading range. When we go back to the D1 chart and know that the ATR is 51 pips, we look at the beginning of the New York session to see how far the price has gone.
In fact, at 15:40 that day we have already reached a trading range of 52 pips.
IMPORTANT: This does not mean that the price can’t continue trading, but that it has already reached its average trading range of the last 50 days.
In other words, we have a first indication that the price may be falling. However, that alone is not enough for us and therefore we add a second indicator.
This second indicator can be a simple support or resistance zone or a moving average. In the following picture we see that the price has just moved towards the EMA200 in D1 and is also moving towards a double-zero level (1.3200). So we already have 3 potential resistances at one point.
If the price has risen up to this level and with this intensity “intraday” without a fundamental reason, you can trade a rebound (i.e. short).
A glance at the economic calendar should also clarify whether a risk event is imminent for one of the two currencies, where renewed volatility could arise.
Such a purely technical approach can work in quiet periods without market-relevant news.
ATR Trading Strategy by J. Welles Wilder
The Wilder Volatility Index Trading System is a strategy that was introduced and developed by J. Welles Wilder in the book “New Concepts in Technical Trading Systems”.
The trading strategy is a long/short system that buys a stock or security when a long signal is generated, and exits and sells the security when a short signal is generated.
The bullish signal occurs when the closing price exceeds the following indicator:
“Previous value of the lowest closing price of the last 7 trading days plus the previous value of the average true spread using a 7-candle period multiplied by three.
The declining signal occurs when the above formula (minus sign is used instead of the plus sign in the short signal) crosses above the closing price”.
The strategy contains no sell or trade rules. A trade is automatically closed when a reverse order is found. The position is closed if it is currently short and a long signal is generated, or if it is bought and a short signal is generated.
The trading system uses the Average True Range (ATR). Instead of the average true range, the Wilders Volatility Index can also be used. This indicator is almost the same as the ATR; the difference is that it allows a constant parameter to be specified in order to weight earlier values more or less heavily.
We have no backtesting result on the strategy and it is not our approach to trade a purely technical system.
With the Average True Range, traders have a technical indicator at their disposal that can be used both for risk management (stop loss) and as the basis of a trading strategy.
We use it to a maximum extent to align the stop loss and to orientate about the strength of a trend.
If you would like to learn more about our trading style, Newstrading, you will find many tips and tricks in our free webinar as well as the presentation of a proven trading setup.