Summary
The Average Range Index (ATR) is a commonly used indicator in technical analysis and is used to estimate market volatility during a specific period. The Average Range indicator is a tool for determining volatility, a concept first introduced by technical analyst J. Welles Wilder Jr. in his 1978 book "New Concepts in Technical Trading Systems."
Over a 14-day period, ATR can be used to calculate estimated price movements of different true magnitudes and use this to determine an average. While ATR has many benefits, including helping traders determine limit and stop loss prices, it does have some limitations.
Introduction
We all know that price volatility goes hand in hand with trading, and this is especially true when it comes to cryptocurrencies. Traders often look to take advantage of these price movements and try to predict the direction. Using technical analysis and price volatility indicators like the Average Range Index (ATR) is one way to do this. For many traders, it is a valuable tool for understanding price movements and has added it to their technical analysis toolkit.
What is the average amplitude indicator?
In 1978, technical analyst J. Welles Wilder Jr. coined the concept of ATR as a tool to measure volatility. ATR has since become one of the most well-known measures of technical volatility.
It is now an important component of other market trend change identification indicators such as the Average Trend Change Index (ADX) and the Average Trend Change Index Rating (ADXR). Traders try to use ATR to determine the best period for trading swings.
This indicator calculates the average market price of an asset over a 14-day period. ATR does not provide trend information or price action, but rather shows price movements during the period. A high ATR means high price volatility for a given period, and a low ATR means low price volatility for a given period.
Traders consider levels of price volatility when determining whether to buy or sell an asset during this period. It is worth noting that ATR only approximates price fluctuations and can only be used as an aid.
How to calculate the average amplitude indicator?
To calculate ATR, you have to find the maximum true range or TR for a specific period. In other words, you need to calculate three different ranges and choose the best one:
Subtract the current lowest price from the current highest price
The absolute value of the current high price minus the previous day's closing price (ignore any negative sign)
The absolute value of the current lowest price minus the previous day's closing price
This period can vary depending on the trader's period of focus. For example, for cryptocurrencies this period could be 24 hours, while for stocks it could be one trading day. To determine the average amplitude indicator for a certain period of time (usually 14 days), it is necessary to calculate the true fluctuation range of each period and sum it, and then take a simple average.
Once the ATR for the period in question is determined, traders can understand the volatility of the asset's price during that time. Typically what traders see as ATR on a chart is a line. Below you can see that the ATR line rises when volatility increases (either price action).
Why do cryptocurrency traders use the Average Range Indicator?
Cryptocurrency traders often use ATR to estimate price volatility over a certain period. ATR is especially useful for the cryptocurrency industry due to the high volatility of the cryptocurrency market. A common strategy is to use ATR to set limit and stop-profit orders and limit-and-stop-loss orders.
When you use ATR to set limit price take-profit orders and limit price stop-loss orders, you can avoid market noise from affecting your trading strategy. When you are unsure about the long-term trend but want to trade, you don't want daily volatility to cause you to close your position prematurely.
A common practice is to multiply the ATR by 1.5 or 2 and then use this number to place a stop limit order at your opening price. Daily fluctuations should not hit your stop-limit trigger price; if it does, it's a good sign that the market is declining significantly.
What are the disadvantages of using the average amplitude indicator?
ATR is characterized by adaptability and price change detection capabilities. Although ATR brings benefits to users, it has two major disadvantages:
1.ATR can have different interpretations. This can be a disadvantage because no ATR value can clearly indicate whether the trend will reverse.
2. Since ATR only measures price fluctuations, it does not notify traders when asset price trends change. For example, when ATR suddenly increases, some traders may believe that this is confirmation of an existing upward or downward trend, and this assumption may be wrong.
Conclusion
ATR is an important tool for many traders in understanding volatility patterns. Since volatility is a key consideration in cryptocurrency trading, it is particularly suitable for digital crypto assets. The beauty of it is that it is simple, but if you decide to use this indicator for trading, please be aware of its limitations.