Tales of a Technician: How I Use ATR
February 1, 2021
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.”
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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