What is average true range?
If you find a book entitled “New Concepts in Technical Trading Systems.” By Welles Wilder, you will find everything you need to know about the average true range since it was introduced there. You will also learn about Parabolic SAR, RSI, and ADX (Directional movement concept) in the book.
The average true range, also known as ATR, is a technical indicator measuring an asset’s price volatility. And when we say volatility, we are talking about the ups and downs or the fluctuation of a price in a given time frame. If the price fluctuation is massive and fast, then the ATR tends to reach a high value. If the price fluctuation is sideways and long during the market’s peak and consolidation, the ATR tends to get a low value.
How to interpret an average true range
Generally, there are two interpretations of ATR. The first one is that if the indicator’s value becomes higher, the trend change probability becomes higher as well. It is the same concept as the second one. As the indicator’s value becomes lower, the trend change probability becomes lower too. We understand that the ATR does not give a price trend indication but a price volatility degree.
Calculating the ATR
Before the ATR value, we need the true range first. And when we talk about the true range, we refer to the latest high and low range and the previous period close. To find the true range, we need three calculations first. After that, we can compare them.
TR is the biggest of the ones mentioned below:
- Current period high — current period low
- Current period high’s absolute value (abs) — the previous period close
- Current period low’s absolute value (abs) — the previous period close
The formula of the true range is:
TR = Maximum [ (high — low), abs (high — previous close), abs (low — previous low)
We use absolute values since ATR does not measure price direction but the volatility mentioned earlier. Absolute numbers are all positive numbers. After getting the true range, we can proceed with ATR. We can say that true range’s moving average is the ATR.
Tell me more about ATR and the true range
Indicators such as average directional movement (ADX), average directional movement rating (ADXR), and many more need true range to know a market’s directional movement. On the other hand, average true range indicator lets us know when market volatility is high or low.
If the volatility is high, the market has a current price fluctuation. On the other hand, if the volatility is low, the market’s price has minimal to no activity.
How vital is average true range?
It is essential to know the average true range to know if the market is volatile. If we see the status of market volatility, we will know the right moves. We will learn about buy and sell signals. We will also have an idea if there is a massive risk.
Markets with high volatility have a risk and reward tendency. Also, given that price movement is always unpredictable and can rise and decline at any moment, the trader can buy and sell. So, we can say that the average true range is beneficial to traders because, again, it tells us when the market is in this state. ATR’s value rises in volatile moments and decreases when there is a minimal price movement.