What is Average True Range - ATR?
The average true range (ATR) is a technical analysis indicator that measures market volatility by decomposing the entire range of an asset price for that period. Specifically, ATR is a measure of volatility introduced by market technician J. Welles Wilder Jr. in his book, "New Concepts in Technical Trading Systems." The true range indicator is taken as the greatest of the following: current high less the current low; the absolute value of the current high less the previous close; and the absolute value of the current low less the previous close. The average true range is then a moving average, generally using 14 days, of the true ranges.
Although, the average true range (ATR) definition given on Investopedia.com is correct my personal use and interpretation of the ATR indicator is somewhat different from what is usually assumed.
One of the first things I will be looking at is a longer ATR term like 80, 100 or even 120 time period calculations, this will give me a much smoother and less volatile indicator which can be used to identify pivot points in the trend reversal or trend continuation. As an ATR becomes lower and tightens it indicates the coming of the end of the trend. As ATR increases and becomes looser it indicated ether beginning of a trend reversal or a trend continuation.
So, in combination with other supporting indicators such as Heikin Ashi bar chart and MACD, we can come to a reasonable conclusion of what kind of action we should take if any.
As for using multiple of an ATR as a level to create your Stop Loss order, we have found this method as very unreliable especially on the initial entry, as it generates a lot of unnecessary Stop Loss kicks and a gradual loss of equity in the account.
Sample Chart Analysis using ATR indicator
As we can see from an 80-period ATR the ETHUSD chart has been squeezing down to lower volatility which is indicated by lower ATR. Also, we can see that the 2-day Heikin Ashi Candles have been producing narrower trading range as well. When both of these indicators combined we can come to a logical conclusion that the direction of a major downtrend is coming to an end.
However, this does not necessarily mean the new trade conditions have been met.
To meet the trading condition one other ingredient must come true:
After hitting a new low ETH must complete an upward move that is greater or equal to multiple ATR levels.
Usually, we can use a multiple of 1 to 1.5 for short term swing trade if we are planning to hold a position from several days to several weeks. Or we can use ATR multiple of 2 to 3 if we are planning to hold a position from 5 days to several weeks and months.
The latest ATR for 01/05/2020 is 15.53 x 1.5 multiple = 23.29
So if we take December 18, 2019 low of 116.25 + 23.29 = 139.54 this gives as our entry point which indicates that when ETHUSD price moves above 139.54 we can reasonably assume that the trend reversal is on its way. If however, the price stays below the trend reversal point, no trend reversal is identified therefor no-trade conditions are met.