TL;DR: The Average True Range (ATR) is a volatility indicator used to determine stop loss and take profit points. Traders can use ATR to set their orders at a distance of 1.5–3 ATR from the open position price.

However, ATR alone does not confirm market trends, so using the TradeDots indicator in conjunction with ATR to indicate better buying and selling points.

Still struggling to determine the best stop loss and take profit points? Then the concept of Average True Range (ATR) can be a game-changer for you. After understanding this technical indicator, you can avoid selling off your assets early before a significant market wave or buying an asset when it’s already at its peak.

About Average True Range

The Average True Range has been a popular volatility indicator for about half a century. It is widely recognized and adopted by seasoned traders in the market. Additionally, it serves as the foundation for other derivative indicators such as Chandelier Exit and Keltner Channels, which are valuable tools for identifying market entry and exit points.

Calculation of Average True Range

The calculation behind Average True Range is straightforward and easily understood. It involves calculating the average of the true ranges over a specified period of time. For each candlestick bar, the greatest number is selected from the following three options:

1. Current high price — Current low price

2. Absolute value of (current high price — previous close price)

3. Absolute value of (current low price — previous close price)

Once the true range for each candlestick is determined, the Average True Range is calculated by averaging the true ranges over a specific time range.

For example, let’s assume the first value of a five-day ATR is calculated at 1.2, and the sixth day has a true range of 1.0. The sequential ATR value can be estimated by multiplying the previous ATR value by the number of days less one, and then adding the true range for the current period to the product.

Next, divide the sum by the selected timeframe. For instance, the second value of the ATR is estimated to be 1.16, or (1.2 * (5–1) + (1.0)) / 5. This formula can be repeated over the entire period.

The ATR is typically calculated over a 14-day period, but it can be calculated over any timeframe. A higher ATR value indicates greater volatility, while a lower ATR value indicates lower volatility.

Trading Strategies with ATR

Find Stop Loss and Take Profit

ATR is an invaluable indicator for determining stop loss and take profit positions. By setting the order at a distance of 1.5–3 ATR from the open position price, traders can effectively manage their risk with better stop loss position.

For example, during the market uptrend of $CVNA, we would want to trail up our take profit and stop loss point, until the asset reaches an recent high at $57 with ATR of 5.1 on the latest green candlestick. Then we will set a take profit point 2*ATR below the open price of that bar, which is $46.8. Then the price hit our targeted take profit price right in the next day.

Find Market Entry and Exits

ATR can also be useful in identifying favorable entry and exit prices during market breakouts and momentum periods. While it doesn’t predict the direction of the breakout, it can help identify changes in market sentiment that drive significant price movements.

One way to utilize ATR in this context is by using the Keltner Channel indicator. This envelope indicator maintains a default 2 ATR distance above and below a 20 EMA line. A breakout from either of the bands signals a trend change or an acceleration of the current trend.

Using the Keltner Channel is simple: buy when the market price breaks through the bottom band and sell when the price exceeds the upper band. The length and multiplier of the band can be adjusted according to your trading style. A larger multiplier widens the range, resulting in fewer trading opportunities but potentially higher profits per trade.

Trading with TradeDots

While ATR and the Keltner Channel indicator have their limitations, they serve to indicate changes in market volatility rather than confirm market trends. Traders must make their own decisions based on whether they believe the volatility will lead to a market reversal or a stronger momentum.

To enhance the accuracy of buying and selling points, the TradeDots indicator can be utilized. This indicator labels market pivot points by analyzing historical price actions. As we can see from the case above, even during a constant market downtrend, TradeDots can help traders exit at the right time, avoiding holding onto losing positions.

Bottom Line

In conclusion, understanding and utilizing the Average True Range can greatly improve your trading decisions. By incorporating ATR into your strategy, you can effectively determine stop loss and take profit points, identify market breakouts. Additionally, combining ATR with indicators like the Keltner Channel and TradeDots can further enhance your trading accuracy and profitability.

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Disclaimer: The information provided in this article is for educational purposes only and should not be considered as financial advice. Trading involves risk, and it is important to conduct thorough research and seek professional guidance before making any investment decisions. Prospective investors are encouraged to perform their own due diligence or consult a financial advisor before making investment decisions.