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The average true range (ATR) indicator is often used in technical analysis to estimate market volatility over a given period. ATR was first described in 1978 by technical analyst J. Wells Wilder Jr. in his book New Concepts in Technical Trading Systems.
ATR can be used to calculate implied price volatility over a 14-day period across different true ranges to determine an average. Although this indicator has its advantages, such as being used in determining the stop loss price, it also has some limitations.
Introduction
Trading can be extremely volatile, especially in the case of cryptocurrencies. Traders try to predict prices and take advantage of these price fluctuations. To do this, they use a variety of methods, including technical analysis and price volatility indicators such as the average true range (ATR). For many traders, this is a valuable tool that must be mastered for further use in technical analysis.
What is Average True Range
The ATR was created by technical analyst J. Wells Wilder Jr. in 1978 as a tool to measure volatility. Since then, ATR has become one of the most popular technical volatility indicators.
It is now used in conjunction with other directional indicators such as Average Directional Index (ADX) and Average Directional Index Strength (ADXR). With the help of ATR, traders try to determine the optimal period for trading volatile price fluctuations.
This indicator calculates the average market price of assets over a 14-day period. At the same time, ATR does not provide specific information about either the trend or the direction of the price, but gives a general idea of โโprice volatility for the specified period. A high ATR implies high price volatility, while a low ATR implies low volatility.
When deciding whether to buy or sell assets during this period, traders take into account low or high price volatility. It is important to note that ATR only approximates price volatility and should be used solely as a guide.
Average True Range Calculation
When calculating ATR, you need to find the largest true range (TR) for a given period. To do this, we calculate three different ranges and select the largest of them:
Last period low minus last period high
The absolute value (without taking into account the minus sign) of the maximum of the last period minus the closing price of the previous period
The absolute value of the low of the last period minus the closing price of the previous period
The period may vary depending on the time chosen by the trader. For example, in the case of cryptocurrencies this period can be 24 hours, and in the case of stocks it can be one trading day. When calculating the average true range over a period of time (typically 14 days), the true range is calculated for each period, summed, and then a simple average is taken.
Determining the ATR for a specified period allows you to get an idea of โโthe volatility of asset prices over this time. Typically, ATR is shown as lines on charts. For example, the chart below shows how the ATR line rises as volatility increases (in any price direction).
Why Crypto Traders Use Average True Range
Cryptocurrency traders often use ATR to estimate price volatility over a given period. ATR is especially useful in cryptocurrency markets due to the high volatility of cryptocurrencies. Many traders use ATR as part of their trading strategies to set take profit and stop loss orders.
Using ATR in this way allows you to avoid the influence of market noise on your trading strategy. When trading an expected long-term trend, a trader must ensure that his positions will not be closed due to intraday volatility.
One popular strategy involves multiplying the ATR by 1.5 or 2 - the result is then used to set a stop loss below the entry price. Daily volatility should not reach the stop loss activation price: if it does, it indicates a significant move down.
Disadvantages of Average True Range
Although the ATR indicator offers many advantages due to its adaptability and ability to track price fluctuations, it has two main disadvantages:
1. ATR does not provide specific data. Uncertainty can be a significant disadvantage for many traders, as no single ATR value can accurately determine whether a trend will reverse or not.
2. Since ATR only measures price volatility, it does not predict changes in the direction of an asset's price. For example, some traders may mistake a sudden increase in ATR as confirmation of an old uptrend or downtrend, but this will turn out to be a mistake.
Conclusion
ATR is a useful market volatility analysis tool that is popular among many traders. Since volatility is a key factor in cryptocurrency trading, this index is great for digital crypto assets. It is easy to use, but has some limitations that should be taken into account when used as part of a trading strategy.