What is ATR? Measuring Volatility with Average True Range
The Average True Range (ATR) is a volatility indicator developed by J. Welles Wilder Jr. Unlike most indicators, it doesn't predict price direction; instead, it measures how much an asset moves on average over a specific period.
How is ATR Calculated?
ATR is based on the 'True Range' (TR). The TR is the greatest of the following:
- Current high minus current low.
- Current high minus previous close (absolute value).
- Current low minus previous close (absolute value).
The ATR is typically a 14-period moving average of these TR values.
Why is ATR Important?
Volatility Measurement
High ATR values indicate high volatility (large price swings), while low ATR values indicate low volatility (consolidating or sideways markets).
Setting Stop Loss Levels
One of the most common uses of ATR is setting stop-loss orders. For example, a trader might set a stop-loss at '2x ATR' from the entry price. This ensures that the stop is wide enough to survive normal market noise but tight enough to protect capital.
Trend Strength
Increasing ATR during a trend indicates that the move is gaining strength and speed. Decreasing ATR during a trend might signal that the trend is losing momentum.
ATR is expressed in absolute price units. An ATR of 100 on BTC is small, but on a stock priced at $50, it is enormous. Always consider the asset's price.
ATR and the Chandelier Exit
The Chandelier Exit is a popular trailing stop strategy based on ATR. It hangs a stop-loss from the highest high (for longs) at a distance of X times ATR, allowing the trade to stay open as long as the trend is intact.
Optimizing ATR with Optimo
The standard 14-period ATR may be too slow for scalping or too fast for long-term investing. Optimo backtests different ATR multipliers (e.g., 1.5x vs 3x) to find the 'sweet spot' that minimizes stop-outs while maximizing profit retention for your specific strategy.
