Last update: July 2021
In response to my recent article on how I view indicators like the MACD, Terry asked for my take on the Average True Range (ATR) indicator.
I think it’s helpful to categorize indicators into one of two buckets. The first I’m calling “Timing Indicators.” The second is “Stock Personality Indicators.”
Most indicators belong in the first category. Traders use the studies like MACD, RSI, Stochastic, etc… to better analyze trends and momentum. Some even use them to generate buy and sell signals.
When it comes to the ATR, however, we’re speaking of the second group. It’s not so much used to forecast price movement as much as it’s used to understand the personality or typical behavior of a stock.
For the newcomer, the Average True Range measures the average candle size. If you’re using a daily chart, then it measures the average daily range. If you’re using a weekly chart, then it measures the average weekly range. So on and so forth.
Take Apple, for instance. Its current daily ATR is $4.44. I can use that information in a few different ways.
Here are three off the top of my head.
- Setting realistic targets.
- Giving adequate room for a stop loss.
- Pre-qualifying a stock to make sure it moves enough to justify trading.
Targets
Suppose I buy AAPL stock for $134, and I want a realistic target that could be hit in a day or two. Instead of obsessing over the chart, I could keep things simple and let volatility (i.e., how much the stock moves) be my guide. How about adding 1 ATR to my entry to arrive at $138.44 as a target?
This is particularly helpful if you want to take partial profits on a quick move in your favor.
The same method applies for establishing realistic targets with bear trades, only you would subtract 1 ATR from the entry.
Stop Losses
Want to reduce your risk of getting stopped out on noise when you’re swing trading? Use ATR to set a stop loss outside the range of normal movement. Take AAPL at $134, for instance. If I place my stop loss at least 1 ATR below my entry (say, < $129.56,) then I ensure that I’ll only get whacked on intraday noise if the stock makes a statistically significant drop over the next day.
This could also apply when moving your stop loss higher after reaching a target. If you want to give the stock room to engage in its normal amount of back-and-forth, then keep the stop loss at least 1 ATR away.
Stock Personality
Some traders will use ATR as a filter when scanning for trade ideas. They’re trying to find stocks that have sufficient volatility before trading them. If a $50 only move 25 cents a day, it doesn’t leave much room for short-term traders to capture profits.
But if that $50 stock moves $2 a day, then there’s plenty of opportunities to get in and out with profits.
One More Thought
If you’re plotting ATR as an indicator on the bottom panel of your chart, then you can see its history, including how it rises as markets crash and falls as markets rise. In this sense, it is a volatility indicator reflecting just how much prices are fluctuating each day. It’s interesting, but I would stop short of pitching it as a good market timing indicator. Hence, my dubbing it a “Stock Personality Indicator.”
Read more Tales of a Technician [FREE Content]
Financial freedom is a journey
Sign up now and gain unfettered access to all of the quality content and powerful Scouting Reports that our Pro Members enjoy for 15-days absolutely free with no strings attached and let us show you what your trading has been missing.
Legal Disclaimer
Tackle Trading LLC (“Tackle Trading”) is providing this website and any related materials, including newsletters, blog posts, videos, social media postings and any other communications (collectively, the “Materials”) on an “as-is” basis. This means that although Tackle Trading strives to make the information accurate, thorough and current, neither Tackle Trading nor the author(s) of the Materials or the moderators guarantee or warrant the Materials or accept liability for any damage, loss or expense arising from the use of the Materials, whether based in tort, contract, or otherwise. Tackle Trading is providing the Materials for educational purposes only. We are not providing legal, accounting, or financial advisory services, and this is not a solicitation or recommendation to buy or sell any stocks, options, or other financial instruments or investments. Examples that address specific assets, stocks, options or other financial instrument transactions are for illustrative purposes only and are not intended to represent specific trades or transactions that we have conducted. In fact, for the purpose of illustration, we may use examples that are different from or contrary to transactions we have conducted or positions we hold. Furthermore, this website and any information or training herein are not intended as a solicitation for any future relationship, business or otherwise, between the users and the moderators. No express or implied warranties are being made with respect to these services and products. By using the Materials, each user agrees to indemnify and hold Tackle Trading harmless from all losses, expenses and costs, including reasonable attorneys’ fees, arising out of or resulting from user’s use of the Materials. In no event shall Tackle Trading or the author(s) or moderators be liable for any direct, special, consequential or incidental damages arising out of or related to the Materials. If this limitation on damages is not enforceable in some states, the total amount of Tackle Trading’s liability to the user or others shall not exceed the amount paid by the user for such Materials.
All investing and trading in the securities market involves a high degree of risk. Any decisions to place trades in the financial markets, including trading in stocks, options or other financial instruments, is a personal decision that should only be made after conducting thorough independent research, including a personal risk and financial assessment, and prior consultation with the user’s investment, legal, tax and accounting advisers, to determine whether such trading or investment is appropriate for that user.
2 Replies to “Tales of a Technician: How I Use ATR”
Thanks Tyler. Is there a specific TOS script to get the green ATR indicator in the upper left portion of the chart? I noticed you don’t always have it visible in the lounges.
Here is the code you can use: http://tos.mx/vsfoQZd
Comments are closed.