Average True Range (ATR): Complete Volatility Guide

The Average True Range (ATR) is one of the most practical indicators in technical analysis. Developed by J. Welles Wilder Jr., ATR measures market volatility by calculating the average range of price movement over a specified period. Unlike many indicators that predict direction, ATR tells you how much a stock typically moves, making it invaluable for risk management and position sizing.

What is Average True Range?

The ATR is a volatility indicator that shows the average amount a security moves up or down during a given period. A higher ATR means the stock is more volatile and moves more in price each day. A lower ATR indicates the stock is less volatile with smaller daily price movements.

How ATR is Calculated

The ATR calculation involves two steps: calculating the True Range for each period, then averaging those values.

Understanding ATR Values

ATR is expressed in the same units as the price (dollars for stocks). Here is how to interpret the values:

• High ATR: The stock is experiencing high volatility and making large moves. This could indicate trending conditions or uncertainty.
• Low ATR: The stock is in a low volatility period with small moves. Often seen during consolidation or before breakouts.
• Rising ATR: Volatility is increasing. Often occurs at the beginning of trends or during market stress.
• Falling ATR: Volatility is decreasing. May indicate a trend is maturing or the market is settling down.

Using ATR for Stop-Loss Placement

One of the most valuable uses of ATR is setting stop-losses that account for normal market volatility. This prevents getting stopped out by normal price fluctuations.

The ATR Multiple Method

The most common approach is to set your stop-loss at a multiple of the ATR below your entry price (for long positions):

ATR-Based Position Sizing

ATR helps you maintain consistent risk across different stocks with different volatility levels. The concept is simple: trade smaller sizes in volatile stocks and larger sizes in less volatile stocks.

The Equal Risk Method

To risk the same dollar amount on every trade regardless of volatility:

• Decide your maximum dollar risk per trade (e.g., $500)
• Calculate your ATR-based stop distance (e.g., 2x ATR)
• Divide your risk by the stop distance to get position size

ATR Trading Strategies

Strategy 1: Volatility Breakout

When ATR rises significantly from low levels, it often signals the start of a new trend. Combine this with a price breakout for confirmation.

• Look for ATR at multi-week or multi-month lows
• Wait for price to break out of the consolidation range
• Enter when ATR starts rising from the low
• Use the expanding ATR to trail your stop

Strategy 2: Chandelier Exit

The Chandelier Exit uses ATR to create a trailing stop that adjusts based on volatility:

• For long positions: Highest High - (ATR x Multiple)
• For short positions: Lowest Low + (ATR x Multiple)
• The stop moves higher as price makes new highs but never moves down

Strategy 3: Range Trading Filter

Use ATR to identify when a stock is likely to stay range-bound versus when it might trend:

• Low and declining ATR: Good for mean-reversion strategies
• High and rising ATR: Better for trend-following approaches

Comparing ATR Across Stocks

Raw ATR values cannot be compared between stocks of different prices. A $200 stock might have an ATR of $8 while a $50 stock has an ATR of $2. To compare volatility, use the ATR percentage:

ATR Settings and Customization

The standard ATR setting is 14 periods, but you can adjust based on your trading style:

• Shorter periods (7-10): More responsive to recent volatility changes. Good for active traders.
• Standard period (14): Balanced view of volatility. Suitable for most swing traders.
• Longer periods (20-30): Smoother ATR that captures longer-term volatility. Better for position traders.

Common ATR Mistakes to Avoid

• Using ATR for direction: ATR measures volatility only, not whether price will go up or down.
• Comparing raw ATR values: Always use percentage ATR when comparing different stocks.
• Setting stops too tight: Using less than 1x ATR often results in getting stopped out by normal noise.
• Ignoring ATR changes: Adjust your stops and position sizes as ATR changes over time.

Summary

The Average True Range is an essential tool for managing risk in your trading. Use it to set intelligent stop-losses that respect normal market volatility, size your positions consistently across different stocks, and understand when markets are transitioning between high and low volatility states. Unlike most indicators, ATR is not about predicting price direction but about trading with awareness of market conditions.

Ready to learn more about risk management? Check out our guide on creating a trading plan or learn about Bollinger Bands.