top of page # Average True Range (ATR): An Essential Tool for Volatility Assessment in Trading

When it comes to trading and investing in the financial markets, knowledge of various technical indicators is invaluable. Understanding these indicators can help investors gauge market trends, predict future movements, and manage risk more effectively. One such crucial metric is the Average True Range (ATR), a technical indicator that measures market volatility. This article provides an in-depth understanding of ATR, its computation, interpretation, and application in trading strategies.

What is Average True Range (ATR)?

The Average True Range (ATR) is a technical analysis indicator used to measure volatility. It was developed by J. Welles Wilder in the 1970s for commodities but has since been applied across various financial instruments, including stocks, forex, and futures. ATR doesn't provide a directional bias or predict price trends. Instead, it measures the degree of price volatility by decomposing the entire range of an asset's price for that period. Increased ATR values indicate greater price volatility, while lower ATR values suggest lower volatility. Calculating ATR

Calculating the ATR involves three primary steps:

True Range (TR) Calculation: The TR for a period is calculated as the greatest of the following:

• Current high minus the current low.

• The absolute value of the current high minus the previous close.

• The absolute value of the current low minus the previous close.

Initial ATR Calculation: The initial ATR is calculated as the average of the TR over a given period, commonly 14 periods.

Subsequent ATR Calculation: For subsequent periods, the ATR is smoothed using the following formula: ATR = [(Prior ATR x 13) + Current TR] / 14

The diagram Depicts

• The True Range (TR) for each period as yellow.

• The initial ATR, represented by the red dashed line and red shaded area.

• The subsequent ATRs, represented by the green dots and green shaded areas.

Interpreting ATR

Higher ATR values imply higher volatility and potentially higher risk, while lower ATR values indicate lower market volatility. A rising ATR often suggests that traders are willing to pay more to enter the market, which can indicate increasing enthusiasm or fear about the underlying security. Conversely, a declining ATR could indicate waning interest or indecision.