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Understanding the Average True Range (ATR)

Average True Range
Average True Range

In the dynamic world of trading and investing, the ability to gauge market volatility is crucial. One of the most commonly used indicators for this purpose is the Average True Range (ATR). Developed by J. Welles Wilder in 1978, ATR provides traders with a quantitative measure of price volatility. This article offers an in-depth look at the Average True Range, explaining its calculation, interpretation, and application in trading strategies.

What is Average True Range (ATR)?

The Average True Range is a technical indicator that quantifies the degree of price volatility. Unlike other volatility indicators that measure the difference between the high and low prices or the opening and closing prices, ATR measures the range of price movement over a specified period.

Why is it Important?

ATR is invaluable for traders and investors as it helps assess the market’s enthusiasm or lack thereof for a particular asset. It also assists in determining position size and setting stop-loss orders, among other applications.

Calculation of Average True Range

True Range

Before delving into the ATR itself, understanding the concept of True Range is essential. The True Range of an asset for a specific period is the greatest of the following:

  • The 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.

Formula for Average True Range

The ATR is calculated as the average of the True Ranges over a set number of periods, most commonly 14 days.

ATR=Sum of True Ranges over N periodsN\text{ATR} = \frac{\text{Sum of True Ranges over N periods}}{N}

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