How to Use the ATR Indicator
One of the best-known technical analysts to first write at length about using volatility as a trading indicator was J. Welles Wilder. In his 1978 book 'New Concepts in Technical Trading', he introduced many cornerstones of modern technical analysis, including the Relative Strength Index (RSI), the Parabolic SAR Indicator (PSAR) and the Average True Range Indicator (or ATR indicator). But what is average true range?
In this article, we will explain what the Average True Range indicator is, what it measures and how to use the ATR Indicator in trading with MetaTrader 4 (MT4) and MetaTrader 5 (MT5). We will also take a look at how to use the average true range indicator as part of a trading system.
Table of Contents
What Is the Average True Range Indicator?
The Average True Range indicator measures volatility within the market. But how does the ATR indicator do this?
Wilder developed his indicators while looking at the commodity markets, and realised that measuring volatility by solely looking at the day's trading range was too simplistic. Instead, he determined that, in order to provide an accurate figure for volatility within a time period, the previous session’s close needed to be considered together with the current high and low.
Thus, he defined the true range as being the greatest out of the three following values:
- The distance between the current high and the current low
- The distance between the previous close and the current high
- The distance between the previous close and the current low
Wilder then proposed taking an average of this value over several days in order to provide a meaningful representation of volatility. Logically enough, he called this the Average True Range.
Essentially, the Average True Range is a moving average of the true range over a predetermined period of time.
Fortunately, traders who use MT4 or MT5 will not need to worry about working out the average true range formula, as both trading platforms will perform the calculation for you instantly. Next, we will take a look at how to use the ATR indicator in MT4 and MT5.
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How to Use ATR Indicator MT4 and MT5
The Average True Range indicator comes with the standard package of indicators available when you install both MT4 and MT5, meaning that you will not have to perform a separate ATR indicator download.
In both MetaTrader 4 and MetaTrader 5, you will find the Average True Range indicator in the 'Indicators' section within the 'Navigator' window on the left-hand side of the screen, as shown below.
When you add the Average True Range indicator to your price chart, you will be presented with the ATR indicator settings window. The only variable you need to worry about is the ‘Period’.
This is the number of periods over which MT4 or MT5 will make the Average True Range calculation. As shown in the screenshot above of the ATR indicator settings, the default value in both MT4 and MT5 is 14, which is a good starting place for traders to begin with. Once you are more familiar with the ATR indicator, you may wish to experiment using different periods to find out what works best for you.
Once you click 'OK', a graph displaying the Average True Range indicator will appear beneath your main price chart. This is shown below in an hourly GBP/USD chart, with a 14-period ATR indicator applied:
The peaks on the ATR indicator chart above show the more volatile trading times, whereas the troughs indicate less volatile periods. Hovering your cursor on the line chart will provide you with the exact value of the average true range at that particular point in time.
How to Use the ATR Indicator in Trading
As we mentioned earlier, the Average True Range indicator measures the level of volatility in the market. Often, traders misinterpret exactly what this means, confusing volatility for momentum.
Unlike momentum, volatility does not tell us anything about the strength of a trend, nor does it tell us its direction. Instead, it tells us how much the price is fluctuating around the average price.
So, what is average true range used for in trading?
One of the most common uses of the ATR indicator is to help traders place stop loss orders. For example, if the Average True Range indicator is showing that current levels of volatility are low, traders may choose to place a tighter stop loss.
Conversely, when volatility is high, traders may consider placing stop losses further away from their entry level. This is because, when volatility is high, traders will expect larger price movements. Therefore, a stop loss which is too tight may get activated prematurely in a volatile market.
To learn more about how to use ATR indicator for stop loss placement, as well as see how you can use the average true range to estimate the day’s trading range, check out one of our recent webinars on the topic below:
The ATR indicator was originally designed with commodities in mind, but today it is widely applied to both the stock and Forex market and is one of the most popular volatility indicators available.
As the Average True Range indicator does not measure direction and simply considers the magnitude of the range, it has limited use as a means for generating trading signals. However, it is a useful tool for providing an idea about how much a market may move. This, in turn, informs key trading decisions such as stop loss placement.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.