Explore Lucrative Grounds Using Average True Range Indicator
Want to ride the trading waves with a tool that keeps you in the know? Say hello to the Average True Range (ATR). This bad boy has been a trusted kickstand for traders for decades, helping them boost their results. Here's the lowdown on it and why you should give it a whirl.
ATR stands for volatility, and that's exactly what it does: measures the strength of a stock's price action, often overlooked for hints on market direction. Bollinger Bands might be better known in the volatility world, but ATR holds its own. John Bollinger himself acknowledged this in his book "Bollinger on Bollinger Bands" back in 2002, stating that high volatility breeds low and vice versa.
ATR follows a cycle much like Bollinger Bands, but this time, the focus is solely on volatility, omitting price. You can see the lines start out far apart on the left side of the graph, then converge as they move toward the middle. After nearly touching each other, they separate again, signaling a period of high volatility followed by low.
The ATR question, though, is how to profit from this volatility cycle. While it won't predict the direction of the breakout, it can be used for entry or exit signals when added to the closing price. Trading signals occur relatively infrequently, but they spot significant breakout points. When the price closes more than an ATR above the most recent close, it's a sign of a change in volatility, which is betting the stock will continue moving upward.
Traders may choose to exit their trades based on subtracting the ATR from the closing price, closing a long position when the price closes more than an ATR below the most recent close. This method can be applied to any trading technique and is most commonly used as an exit method.
ATR is impressed with its flexibility, adjusting to each stock's unique volatility - a key advantage over fixed-percentage stops. As the trading range expands or contracts, the distance between the stop and closing price automatically adjusts, balancing the trader's desire to protect profits with the stock's need to move within its normal range.
This versatile indicator is suitable for strategies of any time frame, from day trading to longer-term investing. Using a 15-minute time frame, day traders can add and subtract the ATR from the closing price of the first bar. This provides entry points for the day with stops being placed to close the trade if prices return to the close of that first bar.
Now for some insights:
- ATR is unique in that it doesn't focus on the direction of a stock's movement, but rather how significant that movement is.
- The chandelier exit, developed by Chuck LeBeau, involves placing a trailing stop below the highest high the stock reached since the trade was entered. The distance between the highest high and the stop level is defined by some multiples of the ATR.
- Some traders adapt the filtered wave methodology and use ATR instead of percentage moves to identify market turning points. Under this approach, when prices move three ATRs from the lowest close, a new up wave starts. A new down wave begins whenever the price moves three ATRs below the highest close since the beginning of the up wave.
The ATR can help day traders and long-term investors alike. For day traders, it offers flexibility in adjusting strategies based on current market volatility, aiding in precise risk management and setting stop-loss levels. For long-term investors, ATR provides a measure of historical volatility, allowing them to assess potential risks and adjust their investment strategies accordingly.
ATR even offers insights into market conditions, enabling investors to make informed decisions about entering or exiting positions in line with their investment goals. Before you know it, you'll be cruising the market waves like a pro.
- The Average True Range (ATR) is a valuable tool for traders, helping boost results by measuring the strength of a stock's price action and providing insights on market direction.
- Although ATR doesn't predict the direction of a stock's breakout, it can be used for entry or exit signals, especially when added to the closing price, as it indicates significant breakout points.
- ATR offers varied applications in finance, from day trading to long-term investing, including techniques like the chandelier exit and filtered wave methodology, which use ATR to identify market turning points and set stop-loss levels.
- By providing a measure of historical volatility, ATR assists long-term investors in assessing potential risks and adjusting their investment strategies based on market conditions, enabling them to make informed decisions in line with their investment goals.
