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. 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 calculated 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 Investopedia.com’s Average True Range (ATR) definition on Investopedia.com is correct, my use and interpretation of the ATR indicator are somewhat different.
One of the first things I will look at is a longer ATR term like 80, 100, or even 120 time period calculations. This lookback gives a much smoother and less volatile indicator and helps to identify pivot points in the trend reversal or trend continuation. As an ATR becomes lower and tightens, it indicates the end of the trend. As ATR increases and becomes looser, it marks ether beginning of a trend reversal or trend continuation.
So, in combination with other supporting indicators such as the 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 an ATR as a level to create your Stop Loss order, we have found this method 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 on the ETHUSD chart, it squeezes down to lower volatility indicated by a lower ATR. Also, we can see that the 2-day Heikin Ashi Candles have been producing a narrower trading range. When ATR and Heikin Ashi are combined, we can conclude that the downtrend direction is ending.
To meet trading conditions, we must have one additional ingredient 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 an ATR multiple of 2 to 3 if we intend to keep 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 an entry point that indicates that when the ETHUSD price moves above 139.54, we can reasonably assume that the trend reversal is on its way. No trend reversal is identified if the price stays below the trend reversal point; therefore, trade conditions are not met.