Market volatility is often the reason traders can profit from price changes. The market never stays still: constant swings drive prices higher or bring them lower. Volatility is a normal part of the trading process and while it does make trading riskier, it can also be helpful if caught at the right time. How to measure volatility and catch better timing to enter or exit the market? This is when the Average True Range indicator (ATR) comes in handy.
What Is the ATR Indicator Used For?
The Average True Range indicator measures market volatility. Its calculation is based on the following values:
- Difference between the current high and low;
- Difference between the current high and the previous closing price (absolute value);
- Difference between the current low and the previous closing price (absolute value).
Originally, the indicator was developed to be used with commodities. However it is suitable for any instrument you wish to trade. ATR can be used with different periods, which makes it a universal tool. The default period that the indicator is set to is 14, but traders can increase or decrease it depending on the length of the trade they wish to execute.
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Reading ATR Indicator Signals
To understand how ATR works, let’s look at this indicator applied to the USD/JPY chart on the IQ Option traderoom.
The blue indicator line is the ATR line which fluctuates between values on the right side. These values reflect the volatility intensity and can give a hint about the state of the market.
Generally, ATR stays at low values when the market is calm and a sideways trend is formed. After a long sideways trend, a powerful trend (downward or upward) can be expected. Then the indicator starts growing and indicates that volatility is increasing. When the indicator reaches high values, it may signal that the trend is over and soon will reverse.
How to Trade According to ATR Signals?
- When ATR starts growing from low values, a trader can enter a trade according to the emerging trend direction;
- When ATR reaches high values and is about to reverse or go sideways, a trader may exit the deal and lock in profits;
- It is important to combine ATR with trend-following indicators for more accurate signals.
The Average True Range values should always be compared to the previous values in order to get a feel of the strength of the trend. ATR does not provide 100% accuracy and it is not possible to enter and exit deals based on its signals alone.
Example
In the example below you can see how EUR/USD enters a downtrend and ATR, starting with low values, is rising slowly to higher volatility values.
By the end of the trend, the indicator drops to lower values again, reflecting a sideways trend. Combining this signal with indications from other tools, traders could use it to enter a deal at the beginning of the downtrend to ride it until the reversal.
ATR Indicator Strategy: Double ATR Method
An example of an indicator combination with ATR is the Double ATR strategy. It uses the Average True Range, ATR Trailing Stops and a Simple Moving Average to find entry points in the market.
Watch the full video to learn more about the Double ATR method.
ATR Indicator Settings
Setting up ATR is fairly easy, since the only task a trader has is to decide on the period of the indicator. To set up ATR on the IQ Option platform, you may follow the steps:
- Find Average True Range in the list of Popular indicators in the traderoom and click on it;
- Choose the color of the ATR line as well as the period of the indicator. The default period is 14, however you may change it according to your preference. Generally, the shorter the trading time frame, the smaller the period of calculation and vice versa;
- Click Apply to set up the indicator on the chart. The indicator is ready to be used!
ATR settings on the IQ Option platform
If you wish to reset the indicator to default settings, simply click on the “By default” button.
Conclusion
The Average True Range indicator is an effective tool to measure market volatility. While it does not give exact indications regarding entries and exits, it can be successfully used to determine the best time to open or close a trade, based on the increasing or diminishing volatility. ATR indicator works best when combined with trend-following tools, for instance, the Moving Average, for better results.
Have you used ATR in your trading strategy? Let us know about your results in the comments below.
