An educational series that we complete with you daily to explore important indicators in trading.
📈 Today's Indicator:- ATR (Average True Range) - A comprehensive guide to understanding volatility.
What is ATR indicator?
The Average True Range (ATR) indicator is a technical analysis tool used to measure the price fluctuations of a particular asset (such as currencies, stocks, or commodities) over a specified period of time. ATR helps traders predict how far the price will move in the future, and is useful in determining the locations of stop-loss and take-profit orders.
ATR development history.
The ATR was developed in 1978 by technical analyst J. Welles Wilder, who also created other indicators such as the Relative Strength Index (RSI) and the Parabolic SAR.
-Understanding volatility and momentum.
Volatility refers to the extent to which an asset's price changes, while momentum reflects the strength of a trend. High-volatility markets have wider price ranges, unlike low-volatility markets.
-How to calculate ATR.
ATR is calculated as the average of the true range (TR) values of an asset, which is defined as the highest value among:-
1- The difference between the current top and the current bottom.
2- The difference between the current high and the previous closing price.
3- The difference between the current bottom and the previous closing price.
The following formula is used to calculate ATR:
\[ \text{ATR} = \frac{(\text{previous ATR} \times 13) + \text{current TR}}{14} \]
where "n" is the number of periods, which is usually specified as 14.
-Interpretation of ATR reading.
An increase in the ATR value indicates higher volatility, while a decrease indicates lower volatility. ATR helps traders identify price targets, such as hitting targets below 100 pips if the currency pair is moving within a 100-pips range.
-Uses of ATR in trading.
1- Identifying breakouts: In low-volatility markets, an increase in ATR indicates a possible breakout.
2- Signal line: ATR can be combined with a moving average to confirm trends.
3- Managing position size: It is preferable to trade with a smaller size in highly volatile markets.
4- Combining ATR with other indicators:-
1- Combining ATR with MACD indicator:-
When a rising ATR coincides with a bullish MACD signal, it may give you stronger confirmation of the beginning of a strong trend.
2-ATR with moving averages:-
If the ATR is rising with a positive crossover between the averages, it indicates a strong move ahead.
-Using ATR to determine exit points.
ATR can be used to set stop loss and take profit orders. For example, if the ATR for GBP/USD is 150 pips, a take profit of 120 pips can be set.
Conclusion:-
The ATR is considered a volatility indicator, not a trend indicator. It reflects the level of activity in the market, with large moves indicating wide ranges. The ATR is also used to validate trends or reversals; a rise during an upward reversal indicates strong buying pressure, while a fall during a downward breakout indicates selling pressure.
The ATR indicator is an excellent tool for understanding market strength and managing risk better. To use it effectively, combine it with indicators like MACD or moving averages, and watch the market carefully to fine-tune your strategy.
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