ATR (Average True Range): Definition, Formula, and How Traders Use It

The Average True Range (ATR) is a popular technical indicator that measures market volatility. Originally, it was developed by J. Welles Wilder Jr. in 1978 and introduced in his book New Concepts in Technical Trading Systems. Unlike indicators that attempt to predict price direction, ATR focuses solely on the degree of price movement. As a result, it helps traders understand how volatile an asset is over a specific period. Therefore, many market participants rely on it to adapt their strategies to changing market conditions.

How ATR Works

ATR calculates the average of the “true range” over a defined number of periods, most commonly 14. Specifically, true range represents the greatest of the following values:

• Current high minus current low

• Absolute value of current high minus previous close

• Absolute value of current low minus previous close

In this way, the formula captures both gaps and limit moves. Consequently, ATR provides a more accurate reflection of volatility than simply looking at daily highs and lows. Therefore, traders often prefer it when assessing market dynamics.

Formula:

ATR = (Sum of True Ranges over n periods) ÷ n

Where n is usually 14.

Example

Suppose a stock has the following daily movements:

• Day 1: High = 105, Low = 95, Close = 100 → TR = 10
• Day 2: High = 110, Low = 100, Previous Close = 100 → TR = 10
• Day 3: High = 108, Low = 97, Previous Close = 110 → TR = 13

Consequently, if the average of these three TR values is 11, then the ATR equals 11. In this way, the indicator clearly reflects the typical range of price volatility.

Why ATR Matters

1. Volatility Indicator: ATR shows how much an asset typically moves, giving traders insight into expected price fluctuations.
2. Position Sizing: Many traders adjust trade size based on ATR; a higher ATR means a smaller position size to control risk.
3. Stop-Loss Placement: ATR helps set dynamic stop-loss levels. For instance, a trader may place a stop-loss at 1.5 × ATR away from entry.
4. Trade Filtering: ATR can be used to filter signals. A breakout with rising ATR is often more reliable than one with falling ATR.

Limitations of ATR

• ATR does not indicate direction—it only shows volatility.
• Values are relative: an ATR of 5 could be high for one stock but low for another.
• In quiet markets, ATR may shrink, potentially leading traders to underestimate risk.

Key Takeaways

The Average True Range is one of the most reliable measures of volatility in technical analysis. In fact, it has become a standard tool among traders who want to understand market dynamics more clearly.

It does not forecast price direction, but rather provides critical context for risk management, trade sizing, and stop placement. Moreover, when it is used in combination with trend indicators, ATR can therefore help traders build robust strategies in both the Forex and stock markets. Ultimately, this makes it an essential component of any professional trading toolkit.

📂 Category

Forex / Technical Indicators

🔗 Related Terms

Volatility, Stop Loss, Risk Management, Position Size, Moving Average, Technical Analysis, ATR Indicator, Indicator