Average True Range (ATR)

The Average True Range is a volatility indicator that was created by J. Welles Wilder and described in detail in his book "New Concepts in Technical Trading Systems". Originally, Welles used the ATR on commodities, but its use was then extended to the other markets.

The Average True Range is a moving average of True Ranges. It measures the degree of volatility for a given period (typically 14 days). If the ATR is high, volatility is high, and the opposite is true as well - if the ATR is low, prices are likely to evolve within a narrow range.

The True Range measures the volatility between the previous closing price and the latest price.

It corresponds to the highest of the following values:

(Day's high - Day's low)
(Day's high - Previous closing price)
(Day's low - Previous closing price)

Using the ATR when trading

The ATR doesn't allow you to predict which way prices will go, but it will help you anticipate the degree of volatility.
Nevertheless, a change in the ATR's level can provide important information.

1) The peak of the ATR is frequently found where there is a summit or an abyss.

2) Periods of low volatility often precede important price movements.

3) Prices often evolve within a horizontal range in low ATR values.

Using the ATR for Money Management

The ATR can help you determine a stop loss order level. You just need to take an ATR multiple and subtract it from or add it to a price. The multiple you use depends on the asset you trade, your risk profile and how much capital you have.

Example with a multiple of 3:

Long GBP/USD at 1.6450 with an ATR of 0.0014

3*0.0014 = 0.0042

1.6450 - 0.0042 = stop at 1.6408, representing 42 pips

You can then determine the size of the position you need so that the 42 pips don't exceed the maximum loss you are willing to bear.