Summary
The Average True Range (ATR) is a technical analysis indicator commonly used to estimate market volatility over a given period. The ATR was created by technical analyst J. Welles Wilder Jr. in his book "New Concepts in Technical Trading Systems", published in 1978, and is used as a tool to determine volatility. .
Over a 14-day period, the ATR can be used to calculate and provide an estimate of price volatility over different true ranges to determine an average. Although the ATR offers several benefits, such as helping traders determine stop-loss prices, it also has some limitations.
Introduction
A well-known aspect of trading is its volatility, especially in the cryptocurrency space. Traders often look for the advantage that these price movements provide and try to predict them. One method that can be effective is technical analysis and price volatility indicators, such as the Average True Range (ATR). For many traders, it is a valuable tool that they want to understand to add to their technical analysis toolkit.
What is the Average True Range?
Technical analyst J. Welles Wilder Jr. created the ATR in 1978 as a tool to measure volatility. Since then, this indicator has become one of the most well-known forms of the technical indicator set to measure volatility.
Currently, it is part of other indicators that identify the directional movement of markets, such as the Average Directional Index (ADX) and the Average Directional Index Score (ADXR). With the ATR, traders try to determine an optimal period for trading volatile swings.
The indicator calculates the average price of assets in the market over a 14-day range. The ATR does not provide information on price trend or direction, but it does provide insight into price volatility over that period. A high ATR implies high price volatility in a given period, and a low ATR indicates low price volatility.
Traders consider these high or low price volatilities to determine whether they want to buy or sell assets during the period. It is important to note that the ATR only approximates price volatility and should only be used as an aid.
How is ATR calculated?
To calculate ATR, you must find the highest true range or TR for a given period. To do this, you must calculate three different ranges and choose the largest of the three:
The high of the last period minus the low of the last period
The absolute value (ignoring any negative signs) of the last period's high minus the previous closing price
The absolute value of the last period's low minus the previous closing price
The period may vary depending on the period the trader takes. For example, with cryptocurrencies, the period could be 24 hours, while for stock stocks it could be a single trading day. To determine the ATR for a period (typically 14 days), the true range is calculated for each period, added, and a simple average is obtained.
Determining the ATR of said period allows traders to know the volatility of asset prices during that time. Typically, a trader will see the ATR displayed as a line on their charts. Below, you can see that the ATR line increases as volatility increases (in either price direction).
Why do cryptocurrency traders use the ATR indicator?
Cryptocurrency traders often use the ATR to estimate price volatility over a period. The ATR is especially beneficial in the cryptocurrency space due to the high volatility seen in the crypto markets. A common strategy is to use the ATR to set take profit and stop loss orders.
By using the ATR indicator in this way, you can prevent market noise from affecting your trading strategies. If you're trying to trade a suspected long-term trend, you don't want daily volatility to close your positions early.
A typical method is to multiply the ATR by 1.5 or 2, then use this figure to set the stop loss under the entry price. Daily volatility should not reach the stop loss trigger price; If it does, it is a good indicator that the market is moving lower significantly.
What are the disadvantages of using the ATR indicator?
Although the ATR provides benefits to its users due to its adaptability and the ability to detect price changes, it has two main disadvantages:
1. It is usually open to interpretation. This can be a disadvantage, as no ATR value can clearly determine whether a trend will reverse or not.
2. As the ATR only measures price volatility, it does not inform traders about the change in the direction of an asset's price. An example is when there is a sudden increase in ATR. In this situation, some traders may believe that an old bearish or bullish trend is being confirmed, which may be a wrong guess.
Conclusions
The ATR is vital in many traders' toolkits for understanding volatility patterns. As volatility is a key consideration in cryptocurrency trading, this indicator is especially suitable for digital crypto assets. Its strength lies in its simplicity, but keep in mind its limitations if you decide to try it in your trading activities.
