The Average true range is a volatility Indicator. Volatility measures the strength of the price action, and is often overlooked for clues on market direction. It is developed originally by Welles Wilder for Commodities. This indicator does not provide an indication of price trend, simply the degree of price volatility.
The average true range is an N-day smoothed moving average (SMMA) of the true range values. Wilder recommended a 14-period smoothing.
The true range is largest of the..,
- Most recent periods high minus the most recent periods low.
- Absolute value of the most recent periods high minus the previous close.
- Absolute value of the most recent periods low minus the previous close.
Simply put, stock experiencing a high level of volatility has a higher ATR, and a low volatility stock has a lower ATR. The ATR may be used by market Technicians to enter and exit trades, and it is a useful tool to add to a trading system.
ATR is calculated to allow traders to more accurately measure the daily volatility of an asset by using simple calculations. The indicator does not provide the price direction, rather it is used primarily to measure volatility caused by gaps and limit up or down moves.
As Wilder suggested, the ATR is typically calculated based on 14-periods, but also can be calculated on an intraday, daily, weekly or monthly basis.
Current ATR = [Prior ATR * 13) + Current TR] / 14.
- Multiply the previous 14-day ATR by 13.
- Add the most recent day’s TR value.
- Divide the total by 14.
Because there must be a beginning, the first TR value is simply the High minus the low, and the first 14-day ATR is the average of the daily TR values of the last 14-days. After that, Wilder sought to smooth the data by incorporating the previous periods ATR value.
To brief it up.., ATR is not a directional indicator, such as MACD or RSI. Instead ATR is a unique volatility indicator that reflects the degree of interest or disinterest in a move. Strong moves in either direction are often accompanied by large ranges or large True ranges. This is especially true at the beginning of a move. A bullish reversal with an increase in ATR would show strong buying pressure and reinforce the reversal. A bearish support break with an increase in ATR would show strong selling pressure and reinforce the support break.