In brief
The average true range (ATR) is a technical analysis indicator commonly used to estimate market volatility over a given period. The ATR is a volatility determination tool created by technical analyst J. Welles Wilder Jr. created in the book "New Concepts in Technical Trading Systems" (roughly translated: New concepts in technical trading systems). This book of his was published in 1978.
Over a 14-day period, ATR can be used to calculate and provide estimated price movements over multiple actual ranges to determine the average value. Although ATR offers many benefits, including helping traders determine stop loss prices, this tool still has some limitations.
Introduce
Volatility is characteristic of trading activities, especially those involving cryptocurrencies. Traders often look to take advantage and try to predict these price fluctuation events. Technical analysis and price action indicators such as the Average True Range (ATR) are a viable way to do this. For many traders, this is a useful tool and worth adding to your technical analysis toolkit.
What is the average true range?
In 1978, technical analyst J. Welles Wilder Jr. creates ATR as a tool to measure volatility. Since then, ATR has become one of the most popular forms of technical indicators for predicting volatility.
Now, ATR is an important part of other indicators and is used to determine the directional movement of the market, such as Average Directional Movement Index (ADX) and Ranking of Directional Movement Index average direction (ADXR). With ATR, traders try to determine an optimal period for trading during periods of volatility.
This indicator calculates the average market asset price over a 14-day period. Instead of providing information about price trends or direction, ATR gives a view of price movements during that period. In a given period, a high ATR means high price volatility, and a low ATR means low price volatility.
When determining whether to buy or sell an asset in a period, this low or high price fluctuation is what traders consider. It is important to note that ATR only estimates price volatility and should only be used as a support measure.
How to calculate Average True Range?
To calculate ATR, you must find the largest true range (TR) of a given period, that is, calculate 3 different ranges and choose the largest among them:
The highest level of the most recent period minus the lowest level of the most recent period
The absolute value (ignoring any negative signs) of the most recent period high minus the previous closing price
The absolute value of the most recent period low minus the previous closing price
The period may vary according to the trader's concentration period. For example, with cryptocurrencies, a period can be 24 hours, while with stocks, a period can be a trading day. To determine the average actual fluctuation range over a period of time (usually 14 days), calculate the actual fluctuation range in each period and sum it up, then easily calculate the average value.
By determining the ATR of the above period, traders can learn about the fluctuations in asset prices during that period. Typically, traders will see ATR displayed as a straight line on the chart. Below you can see the ATR line increases as volatility increases (in both price directions).
Why do cryptocurrency traders use Average True Range?
Cryptocurrency traders often use ATR to determine price fluctuations over a period of time. For cryptocurrencies, ATR is extremely useful due to the high volatility of this market. A popular strategy is to use ATR to set take profit and stop loss orders.
By using ATR in this way, you can limit market noise from affecting your trading strategy. If you're trying to trade an uncertain long-term trend, you don't want daily volatility to cause your positions to be closed prematurely.
Another typical method is to multiply the ATR by 1.5 or 2, then use this number to set a stop loss below your entry price. Daily volatility will not reach your stop loss trigger price; If a stop loss occurs, it is an effective indicator that the market is going down significantly.
What are the limitations of using Average True Range?
While ATR benefits users in terms of adaptability and detecting price changes, the tool has two main disadvantages:
1. ATR has many interpretations. This can be a disadvantage because there is no single ATR value that can clearly determine whether the trend has changed or not.
2. Since ATR only measures price fluctuations, this tool does not inform traders about changes in the asset's price direction. For example, when ATR increases suddenly, some traders may assume that the indicator is confirming an old up or down trend, but this is not necessarily true.
summary
In many traders' toolkits, ATR plays an important role, helping them understand volatility patterns. Since volatility is an important factor to consider in cryptocurrency trading, this tool is especially suitable for digital crypto assets. The advantage of ATR lies in its simplicity, but consider the limitations of this tool if you decide to experiment in your trading activities.
