104 Average true range indicator (ATR)

ATR is used as indicator of volatility, by looking at the highest prior variation in price.

For each time step, ATR is the maximum value among:

  1. High price minus low price, or
  2. Absolute difference between current high price minus prior close price, or
  3. Absolute difference between current low price minus prior close price.

Which ever is highest of the three, is the ATR. ATR is averaged over a prior time period.

ATR can be used to determine the size of a trailing stop. Commonly, the trailing stop is 3x the ATR, this will ensure that volatility will not take you out of a trend and let you ride the trend with the trailing stop.

ATR is also used to buy if the close price in a given day is higher than the ATR plus close price of the prior day. In other words, current price is trading exceptionally higher than prior volatilty and price.

ATR

Figure 12.6: ATR