ATR – Average True Range

This is one of the many indicators included in most charting packages. This indicator known as “Average True Range”, or “ATR” for short, basically tells you the amplitude of each candle on your chart, or more specifically for what it is intended, it tells you the Average over a selected period. The ATR indicator measures volatility but does not provide an indication of price direction or duration; it just shows the degree of price movement or volatility. This indicator was developed by some guy named “J. Welles Wilder” and was introduced to the world in his book “New Concepts in Technical Trading Systems” (1978). It is important to recognize the people who developed new trading systems… especially as I would hope that people will mention me as the brain behind all the techniques I have personally developed (smile). It is not my intention here to explain everything about ATR, especially because the way we will be using it is an adaptation to figure out something important to know for the trading techniques presented here in this book. In the next paragraph I’ll briefly explain what ATR is, and after that I’ll explain how we will be using it, but before I start explaining all that I need to make it very clear to you that the ATR indicator is not a trading method, but rather is just a tool to figure out some important facts that will be useful information for the trading techniques that will be presented later in this book. The True Range (notice I didn’t say “Average”), or TR, is simply the range of the period between the high and the low prices. Technically speaking the above statement seems to be inaccurate according to descriptions I read about TR in Technical Analysis Encyclopedias, but (and fortunately because this is what I really want) the Forex charts I like using seem to provide the TR according to the above description. According to the definitions of manuals (usually written for stock & commodities) the True Range (TR) is calculated by taking the difference from the previous candle’s close to either the extreme high or low of the candle (whichever is the greater of the two).

According to my definition (in context of how I like to consider TR) you simply take the high of the candle and subtract the low of the candle to find the TR. After I explain how to read the TR on your charts I’ll tell you how to check to see which definition your charts use, and what to do if your charts happen to use the “Encyclopedia” method. We won’t be using the ATR indicator as Mr. Wilder has intended it to be used (he developed ATR to accurately reflect the volatility associated with commodities and to account for the gaps, limit moves and small ranges). We are really just interested in the True Range (TR) and don’t pay much attention at all to the “Average” (though I’ll show you a useful thing you can do by finding the Average). To find the True Range simply call up a daily chart of whatever currency pair you want. We’ll discuss other timeframes (i.e. weekly & monthly) later, but let’s first discuss how to find the TR and why we use it. You should find the “ATR” option in the menu of available indicators. Simply select the ATR option and set the period for one (1). A separate chart should now appear (usually on the bottom of your main chart) showing a line that bounces up & down. You should see something like this:

The chart above shows about 8 months of EUR/USD daily candles. When you do this you should select to view the past ten (10) years worth of data to see the maximum amount of information, but the above chart was zoomed in so that you can more clearly see it here. Fortunately for me the charts I currently like to use (Intellichart from Fxtrek.com) display the ATR using the description I prefer rather than the “Encyclopedia method”. The ATR (1 period) chart shows you visually the height of each candle (the high price minus the low price). What the above chart shows you (during the period of time seen) that is of most interest is what are the largest moves; see the peaks along the top? The tallest peak visible above (near the left side of the chart) shows that the biggest move in a single day was 245 pips (to find out exactly how many pips it was simply mouse over the big candle there to see it’s specific details). You also want to look at the other peaks to get a sense of roughly what the largest pip moves that have happened in a single day. Looking at the above you figure out that roughly 200 pips is the usual maximum. Hmmm… that’ll be a good term for this, so we’ll from now on in  

call it the “UdM” (I just made up this term). The “U” stands for “Usual”, the “M” stands for “Maximum”. The small case “d” stands for “daily”, and later “UwM” will be for “weekly” and “UmM” will be for “Monthly”. These terms will come in handy later when I start explaining how to use them for trading purposes (later in this book). Back on topic now. So from looking at the above chart we have decided that the UdM for EUR/USD based on the past year is roughly 200. “200” is a rough guesstimate, but if you really want to get an accurate number then feel free to add up the top ten peaks then divide by 10 to get the average… but honestly I’m often too lazy to do this, so I just wing it. Also on the above chart you can see what were the smallest daily moves (on the above chart 37 pips was the smallest day), but for the most part this is useless information (except you’ll be interested in knowing what the small end of the spectrum is for the “Teeny Netless Candles” taught later in this eBook). Now notice that we found the UdM to be roughly 200 pips by looking at the past year. For most purposes, just looking at the past year is sufficient to find the UdM for any currency pair of interest to you. Now if you were to look over the past 10 years you would notice that there are more peaks that are higher (the tallest one I’ve found on EUR/USD is 454 pips – obviously due to some FA or big news) and by looking at this bigger picture it would appear that the usual maximum would be around 240ish. Bottom line is that this isn’t an exact number you are going for, but rather just an approximation of what the average big days are. For our purposes we’ll consider EUR/USD to have a UdM of 200 pips. It is important to remember that 200 isn’t a fixed ceiling of the maximum EUR/USD can move in a day, since there have been days that were bigger and surely there will be bigger days also in the future, but for usual 200 can be considered a ceiling for how we plan to use it. Now you want to figure out what the Average daily Range is (we’ll abbreviate it as “AdR”). This is quite simple to do by setting your ATR at 240 (roughly how many days there are in a year). Below is the ATR set at 240 for EUR/USD since the year 2000.

This calculates for you the Average daily Range (AdR). As you can see, at the time of writing this, the AdR is 112 pips. This means that the average difference between the daily high & the daily low is currently 112 pips for EUR/USD. Remember, this is just an average – some days will move less and some days will move more. Here is an interesting aside: Often you hear references that the market moves about X pips a day. Well now you know how to find out precisely how much for any currency pair of interest to you.