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The Average True Range (ATR) is a technical indicator used in finance to measure the volatility of an asset, usually a stock or currency. It was introduced by J. Welles Wilder in his book, "New Concepts in Technical Trading Systems." The ATR measures the average range of price movements over a given period of time, typically 14 days.
The ATR indicator can also be used to set a stop-loss level, which is a predetermined price level at which a trader will exit a trade if the market moves against them. A trader might set a stop-loss at a level equal to the ATR value, as this will help ensure that the stop-loss level is proportionate to the level of market volatility.
Another common use of the ATR is to determine position sizing. A trader might use the ATR to calculate the appropriate size of a position, based on the level of volatility and the amount of capital they have available for investment.
The ATR can also be used to identify market trends. A rising ATR indicates that market volatility is increasing, which can indicate that a trend is developing. On the other hand, a declining ATR suggests that market volatility is decreasing, which could indicate that a trend is coming to an end.
The prime component of the ATR formula is the True Range (TR) value. The TR (Current TR) is the greatest of the following:
TR = max [(high − low), abs(high − closeprev), abs(low – closeprev)]
=AVERAGE(TRUE RANGE)
Where TRUE RANGE
is calculated as:
=MAX(HIGH - LOW, ABS(HIGH - PREV_CLOSE), ABS(LOW - PREV_CLOSE))
Where:
HIGH
is the current period's high priceLOW
is the current period's low pricePREV_CLOSE
is the previous period's close priceThe ATR is calculated by taking the average of the TRUE RANGE
over a specified number of periods, typically 14 days.
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atr = avg(tr, 14) tr = max(high - low, abs(high - close[1]), abs(low - close[1]))
Where:
atr
is the Average True Rangetr
is the True Rangehigh
is the current period's high pricelow
is the current period's low priceclose[1]
is the previous period's close price14
is the number of periods over which the ATR is calculatedThe ATR can be plotted as a line on a price chart and is typically used to help traders identify market trends, potential reversal points, and stop-loss levels. The higher the ATR, the greater the volatility, and vice versa.