What is the ATR?
ATR stands for Average True Range and indicates how much the price of a stock has moved during a certain period of time. The ATR therefore provides an indication of how volatile the stock in question is. Unlike the similar ADR indicator, the ATR indicator also includes gaps, providing a more informative and accurate picture.
The ATR indicator was developed by Welles Wilder in 1978, along with the RSI indicator, and was intended to assist in making trading decisions due to the large fluctuations in the commodity and futures markets.
How to Profit from the ATR Indicator in Trading
The ATR indicator can provide a better indication of how and how far a stock may move in the future. Additionally, the value of the ATR indicator is often used to place a profit target and stop loss.
The ATR is similar to a moving average and is usually represented as a line on the chart. Like other indicators, the period length can be changed. The default period length is 14.
The ATR indicator is usually represented as a line with a scale on the chart
As the ATR indicates the average true range of a stock, it can be used to estimate how much the stock will move. The value therefore provides a kind of "range of motion" that can be used to make trading decisions.
The ATR in Trading Example
For example, if the value of the ATR is 7%, this means that the stock has moved an average of 7% during the observation period. Thus, there is a certain probability that it will move within this range in the next trading session as well.
If we then find that the same stock has already moved 5% during the day, a profitable entry into this stock no longer seems sensible. Because there would only be "room" for a 2% movement. The stock has simply already made most of its possible daily movement. An entry at this point would be at the expense of a poor risk-reward ratio (CRV).
Instead, if we find during the day that the same stock has only moved 1%, a trade appears much more lucrative and logical. In this case, the trade would still have sufficient room and potential energy. The CRV would also be significantly better in this example.