How to Use Average True Range Indicator (ATR) in Forex Trading

ForexTradingwithAverageTrueRangeIndicator(ATR):KeyTakeawaysThereareseveralbenefitsthatforextraderscanderivefromusingtheATRindicator:1.Predictingvolatility:TheATRindicatorisoftenusedbyforextraderstopredictthepotentialvolatilityofacurrencypair.2.Determinepositionsize:Byknowingthevolatilityofacurrencypair,traderscanusetheATRtoestimatetheappropriatepositionsizetotakeonatrade.3.Riskmanagement:TheATRindicatorcanbeusedtosetstop-lossordersatsafedistancesfromentrypoints,dependingonhowvolatilethecurrencypairis.4.Trendidentification:ATRisalsocapableofidentifyingmarkettrends.IncreasingATRvaluesindicateanincreasingtrendwhiledecreasingATRvaluesindicateadecreasingtrend.5.Trendconfirmation:ATRcanalsobeusedtoconfirmthestrengthofatrend.HighATRvaluesmayindicateastrong,long-termtrendandalow,fallingATRvaluesuggestsaweaktrend.

What Is the Average True Range (ATR)？

The Average True Range (ATR) is a technical analysis indicator that measures the volatility of a financial instrument over a specified time period. It is calculated as the average of the true range values over a certain period of time.

The true range is the highest of the following three values:

• Difference between the current period‘s high and the current period’s low

• Difference between the current period‘s high and the previous period’s close

• Difference between the current period‘s low and the previous period’s close

The Average True Range Indicator (ATR) oscillates up and down as price movements in an asset increase or decrease. With each passing period, the ATR is calculated anew. In a one-minute chart, the ATR is calculated every minute. For a daily chart, an ATR is calculated every day. On a graph, all the readings are plotted as a continuous line, allowing traders to observe how the volatility of the financial instrument has changed over time.

TheAverageTrueRangeIndicator(ATR)wasintroducedtothefinancialmarketbymarkettechnicianJ.WellesWilderJr.inhisbook“NewConceptsinTechnicalTradingSystems”asamethodofassessingmarketvolatilitybyanalyzingtheentirepricerangeofanassetovertime.TradersusetheATRindicatorincombinationwithothertechnicalindicatorstohelpthemmakeinformeddecisionsabouttheirtrades.

How to Read the Average True Range (ATR)？

The Average True Range Indicator (ATR) is typically displayed as a single line on a chart in which the line moves up and down. Reading the ATR indicator is very simple: higher ATRs indicate increased volatility, while lower ATRs indicate decreased volatility. In this case, the ATR values are measured in pips.

Here are a few ways to understand the Average True Range Indicator (ATR) much better:

• Range expansion:If the ATR value increases, it may indicate that the range of price movements for the financial instrument is expanding. An indication of this could be the beginning of a trend change or a break from the current trend.

• Range contraction:If the ATR value decreases, it may indicate that the range of price movements for the financial instrument is contracting. Possibly, this indicates that the current trend is weakening and may be coming to an end.

• Trend confirmation:Traders can also use ATR to confirm the strength of a trend. If the ATR value is high and rising, it may indicate that the trend is strong and likely to continue. If the ATR value is low and falling, it may indicate that the trend is weak and is unlikely to continue.

It is important to note that the Average True Range Indicator (ATR) must be used in conjunction with other technical indicators and analysis tools since it only indicates volatility and not price direction.

How to Calculate Average True Range？

To calculate the Average True Range Indicator (ATR), you will need to first calculate the true range for a given period, and then calculate the average of the true range values over a specified number of periods.

True Range includes both the current period‘s high and low ranges and the previous period’s closing price (if needed).

Here is the formula for calculating the true range:

TrueRange=max[(high–low),abs(high–previousclose),abs(low–previousclose)

To put it in broader terms,

True Range = Max (current period‘s high – current period’s low, absolute value of current period‘s high – previous period’s close, the absolute value of current period‘s low – previous period’s close)

The absolute value is used since the ATR doesn‘t measure price direction, just volatility. That means there can’t be any negative numbers.

Average True Range Indicator (ATR) is calculated by taking the average of the true ranges for a given number of periods. For example, to calculate the 14-period ATR, you would need to take the average of the true ranges for the past 14 periods.

Here is the formula for calculating the ATR:

CurrentATR=((PriorATRx13)+CurrentTR)/14

To put it in broader terms,

Current ATR = (previous ATR x (periods – 1) + current periods true range) / periods

Average True Range Indicators are typically based on daily price data, so the periods in the formula above would typically represent days. The ATR can be calculated using any timeframe, such as weekly, monthly, or hourly.

Forexample,let'ssayUSD/JPYhitsahighof115.73andalowof115.32intoday'ssession,afterpreviouslyclosingat115.98.*115.73-115.32=41*115.73-115.98=-.25*115.32-115.98=-.73Amongthethreefigures,-.73isthegreatest.Therefore,thecurrenttruerangecanbecalculatedbysubtractingthehighfromthelow.Bydefault,theATRindicatordisplaysamovingaverageofthelast14sessions.Justlikemostindicators,itcanbecustomizedtoincludeasmanysessionsasthetraderwishes.Traderswhotradeshort-termoftenuseATRsoftensessionsorfewer.RoleofAverageTrueRangeIndicator(ATR)inForexTradingTheAverageTrueRangeIndicator(ATR)canprovideseveralbenefitstoforextraders.Someofthekeybenefitsinclude:Improvedriskmanagement:Byunderstandingthevolatilityofcurrencypairs,forextraderscandetermineastoplosslevelthatisappropriatefortheirtradingstrategy.Astop-lossorderlimitstheprobabilityoflosingonatradebysellingacurrencypairatagivenprice.Bysettingastop-lossorderatalevelthatisappropriateforthelevelofvolatilityofthecurrencypair,traderscanmanagetheirriskandprotecttheircapital.Confirmedtrends:Asmentionedearlier,theATRcanbeusedtoconfirmtrendsinthemarket.SinceATRgivestradersaquicksnapshotofhowmuchamarketmovesonagivenday,traderscanuseittodecidewhethertotradeasignalprovidedbyanotherindicator.IftheATRisincreasing,itmayindicatethatatrendreversalisimminent,whileadecreasingATRmayindicatethatatrendiscontinuing.Enhancedtradeplanning:TradingwiththeAverageTrueRangeIndicator(ATR)allowstraderstotakeadvantageofthevolatilityofcurrencypairstoplantheirtradesmoreefficiently.ByusingtheATRtoidentifypotentialentryandexitpoints,traderscanimprovethetimingoftheirtradesandpotentiallyincreasetheirchancesofsuccess.Determinepositionsize:TraderscanusetheAverageTrueRangeIndicator(ATR)todeterminetheappropriatepositionsizetotakeontradebyunderstandingthevolatilityofthecurrencypair.Asaresult,traderscanmanageriskandensurethattheiraccountisnotoverexposedtotheriskofloss.Betterunderstandingofmarketconditions:ForextraderscanalsousetheATRindicatortogetabetterunderstandingofcurrentmarketconditionsandhowvolatileacurrencypairwillbe.Traderswhoareinterestedinmakinginformedtradingdecisionscanfindthisinformationveryuseful.AverageTrueRangeIndicator(ATR)valuescanbeeasilyinterpretedbyusingasimpleandstraightforwardmethod.Tradingmarketsfluctuatefromperiodsofhighvolatilitytoperiodsoflowvolatility,andATRcanhelptraderstokeeptrackofthesechangesassoonastheyoccur.BestATRIndicatorCombinationsforForexTradingTherearemanydifferenttechnicalindicatorsthatcanbeusedincombinationwiththeAverageTrueRangeIndicator(ATR)tohelpforextradersmakeinformedtradingdecisions.SomeofthebestATRindicatorcombinationsinclude:ATRandMovingAveragesBycombiningtheAverageTrueRange(ATR)Indicatorwithmovingaverages,suchasthesimplemovingaverage(SMA)ortheexponentialmovingaverage(EMA),traderscanidentifytrendsanddeterminetheirstrengths.IftheATRisincreasingwhilethemovingaverageistrendingupward,itmaybeasignofastronguptrend.Ontheotherhand,iftheATRisdecreasingwhilethemovingaverageistrendingdownward,itmaybeasignofastrongdowntrend.ATRandStochasticOscillatorForexstochasticindicatorisidealfortradingrangingmarketsbecausetheydeliveroverboughtandoversoldsignals.TheATRhelpsqualifyrangingmarketsandavoidwhipsawsignalsthatcanbegeneratedbyStochasticsinnon-rangingmarkets.LowATRvaluesconfirmrangingmarketsandbuy/sellsignalscanbeprovidedbyStochasticscrossoversinoverboughtandoversoldzones.WiththeAverageTrueRangeIndicator(ATR)combinedwithoscillators,traderscanalsogaininsightintomarketmomentumandidentifypotentialreversals.ATRandParabolicSARParabolicSARindicatorhastheadvantageofbeingviablefortradingtrendingmarkets.CombiningtheAverageTrueRangeIndicator(ATR)withtheParabolicSARindicatorhelpsforextradersestablishclear-cutstoplossandtake-profitpricelevelsthatwillallowthemtomaximizetheirprofitswhileminimizingriskexposure.IftheATRisincreasingwhiletheParabolicSARisindicatingatrendreversal,itmaybeasignthatthetrendreversalislikelytooccur.Ontheotherhand,iftheATRisdecreasingwhiletheParabolicSARisindicatingatrendcontinuation,itmaybeasignthatthetrendislikelytocontinue.ATRandChartPatternsTheAverageTrueRangeindicator(ATR)canbeusedincombinationwithChartpatternstohelptradersgetasenseofthevolatilityofthemarketandthepotentialforatrendreversal.Forexample,iftheATRisincreasingwhileaheadandshoulderschartpatternisforming,itmaybeasignthatthemarketisbecomingmorevolatile,andatrendreversalisimminent.Ontheotherhand,iftheATRisdecreasingwhileadoublebottomchartpatternisforming,itmaybeasignthatthemarketisbecominglessvolatileandthetrendislikelytocontinue.ATRandTrendLinesForextraderscanalsousetheAverageTrueRangeindicator(ATR)withtrendlinestodeterminethestrengthofatrend.IftheATRisincreasingwhilethepriceistrendingalongastrongtrendline,itmaybeasignofastrongtrend.ThisisbecauseanincreasingATRcanindicatethatthemarketisbecomingmorevolatile,whichcouldbeasignofincreasedbuyingorsellingpressure.Conversely,iftheATRisdecreasingwhilethepriceistrendingalongaweaktrendline,itmaybeasignofaweakeningtrend.ThisisbecauseadecreasingATRcanindicatethatthemarketisbecominglessvolatile,whichcouldbeasignofalackofbuyingorsellingpressure.UsingATRforForexDayTrading:Isitagoodidea？TheAverageTrueRangeIndicator(ATR)canbeausefultoolfordaytraders,asitisameasureofvolatilityandcanhelptradersidentifypotentialbreakoutopportunities.However,itsimportanttokeepinmindthattheATRshouldbeusedinconjunctionwithothertechnicalanalysistoolsandshouldnotberelieduponexclusively.Forexdaytradinginvolvestakingadvantageofshort-termpricemovements,andtheAverageTrueRangeIndicator(ATR)canbeusedtohelpidentifyperiodsofhighorlowvolatility.Forexample,atradermayusetheATRtosetstoplosslevelsortoidentifypotentialentryorexitpointsfortrades.Onanintradaychartsuchasaone-orfive-minutechart,theATRspikeshigherwhenthemarketopens.It'sbecausetheopenrepresentsthemostvolatiletimeoftheday,andtheATRrepresentsthevolatilitythatwaspresentyesterday.AssoonastheATRspikesattheopen,itdeclinesthroughouttheday.Throughouttheday,theAverageTrueRangeIndicator(ATR)doesn'tprovidemuchinformationexceptforhowmuchthepricemovesonaverageeachminute.Theone-minuteATRcanbeusedbydaytraderstoestimatehowmuchanassetcouldmoveinfiveortenminutes,muchliketheyusethedailyATR.Establishingprofittargetsorstop-lossordersmaybeeasierwiththisstrategy.TheATRcanbeausefultoolfordaytraders,butitmustbeintegratedintoacomprehensivetradingstrategythatincludesothertechnicalanalysistoolsandriskmanagementstrategies.LimitationsofAverageTrueRangeIndicator(ATR)Likeanyotherforextechnicalanalysistool,theAverageTrueRangeindicator(ATR)hasitsownsetoflimitations.HereareafewpotentiallimitationsoftheATR:Itisalaggingindicator:TheATRindicatordrawsitsdatafrompastpricedata,whichmakesitunreliableatpredictingfuturepricemovements.Indicatorslikethisaremoreusefulasconfirmationtoolsratherthanasleadingindicators.Itissensitivetopricechanges:TheATRisbasedonthedifferencebetweenthehighandlowpricesofasecurityoveragivenperiodoftime.Thismeansthatitissensitivetopricechangesandmaynotprovideacompletepictureofmarketconditions.Itmayproducefalsesignals:TheATRcanproducefalsesignalsinrangingorsidewaysmarkets,asitisbasedonpricemovements.ThiscanleadtoincorrecttradedecisionsiftheATRisusedinisolation.Itdoesnottakeintoaccountmarketfundamentals:TheATRisapurelytechnicalindicatoranddoesnottakeintoaccountmarketfundamentals,suchaseconomicnewsorearningsreports.Thismeansthatitmaynotaccuratelyreflecttheunderlyingdriversofpricemovements.Overall,it‘simportanttousetheAverageTrueRangeIndicator(ATR)aspartofacomprehensivetradingstrategythatincludesothertechnicalanalysistoolsandtakesintoaccountmarketfundamentals.It’salsoimportanttopracticeriskmanagementwhentradingandtobeawareofthelimitationsofanyindicator.GettingstartedwithForexTradingiseasywithCentAccountsAcentaccountisatypeofforextradingaccountthatallowstraderstotradeinsmallincrements,withtheminimumtradesizebeingjustonecent.Thiscanbeappealingforforexnewbies,asitallowsthemtotradewithasmallercapitalbaseandpotentiallyminimizetheirrisk.Acentaccountprovidesalow-riskwayoftradingthatallowsyoutoexperimentwithdifferenttradingstrategieswhilealsohoningyourskillsandgainingexperienceatthesametime.However,withasmallercapital,youwillonlybeabletoachievesmallergains.It‘snotthebestideatoopenaForexcentaccountifyouwanttomakelargeprofits.Withexperience,you’llbeabletomovetoastandardaccountandbenefitfromthebestpromotionaloffersofferedbyyourbroker.Disclaimer:ThispostisfromAximdailyanditisconsideredamarketingpublicationanddoesnotconstituteinvestmentadviceorresearch.Itscontentrepresentsthegeneralviewsofoureditorsanddoesnotconsiderindividualreaderspersonalcircumstances,investmentexperience,orcurrentfinancialsituation.