Forex Tool: Average True Range
Having different tools available gives the flexibility to make adjustments to your trading strategy as market conditions change. Don Dawson introduces average true range and discusses how it is used in making trading decisions.
The true range is the greatest of the following:
- The difference between the current high and the current low.
- The difference between the current high and the previous close in the event of a gap.
- The difference between the current low and the previous close in the event of a gap.
ATR is calculated by taking an average of the true ranges over a fixed number of previous periods of data. The key is to use a variable that is not too short or too long. I have found that using a number between 9 and 14 works well with a fair number of sample points. I use the daily bar chart to calculate the average true range for the markets that I trade, not an intra-day chart (5, 15, 60 minute, etc).
ATR is simply telling us how much a futures contract has moved up or down on average over the defined period we choose. When the ATR is high, the study is telling us that price ranges are larger and more volatility can be expected. When the ATR value is low, the study is indicating that price ranges are smaller and we can expect less volatility. An observation I have seen is that in bear markets we tend to see much higher levels of average true range because of the fear that is in the markets. Bull markets tend to create complacency and fear levels subside causing the volatility to be reduced.
Download Complete Average True Range.pdf
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