ATR -What is it?
ATR stands for Average True Range and it is used to get the average value range of an asset.
Why is knowing the ATR of benefit?
ATR provides the average price range over a certain period of time. This provides the volatility otherwise known as the movement of the price. Knowing the average volatility by knowing how much an asset has moved in an average time informs you of the potential movement for that asset.
Once you are aware of the potential movements of an asset, you can then predict how you expect it to move in the future.
Stop losses could be set below the lows previously encountered. As you would then expect a change in direction of movement before this stop loss point.
This is why ATR is an important element of many stop loss strategies and is particularly relevant for day trading.
This is also beneficial as we are able to discuss in calculating your stop loss.
So How to Calculate the Stop loss using ATR
Stop loss trading is important as if you are not setting stops, larger losses can occur. But a stop-loss should only be hit if you incorrectly predicted the direction of the market. If using tradingview or another chart you can just select the ATR Setting and input the length of time you want the average for. An alternative method is to use a spreadsheet or document the high, closing value, and low points of the asset for each element (hour or day etc) in the range of time.
Then determine and record the true range for each element (hour or day etc) by determining which of the three values is the largest for that element:
- High point position minus the low point position
- High point position minus the previous close position
- Low point position minus the previous close position
Add up all the element values and divide by the number of elements to then determine the ATR.
What length for input should I use to create an ATR?
If you thought the market was volatile and you were unsure of how low it could go. A higher value for determining your average should be used as you are expecting potential fluctuations (volatility).
How to calculate the ATR Stop loss value to put on a BUY or SELL position
Buying price MINUS ATR = Stop loss
Selling price PLUS ATR = Stop loss
What are the alternatives to determining an ATR stop loss?
A fixed stop loss point could be created from your own assumptions or analysis. Set a certain amount for every trade from the current position?
BUT WOULD this consider the volatility in the market and the recent market trends?
A trailing stop loss point trails the asset’s price range, it can be used as an alternative or with an ATR!!