Average True Range

You may have read that many traders use the average true range for setting their stop losses. The reason is that the average true range is a fantastic measure of volatility and market noise.

Very simply, the average true range (ATR) determines a security’s volatility over a given period. That is, the tendency of a security to move, in either direction.

More specifically, the average true range is the (moving) average of the true range for a given period. The true range is the greatest of the following:

# The difference between the current high and the current low
# The difference between the current high and the previous close
# The difference between the current low and the previous close

If the current high-low range is large, chances are it will be used as the True Range. If the current high-low range is small, it is likely that one of the other two methods would be used to calculate the True Range. The last two possibilities usually arise when the previous close is greater than the current high (signaling a potential gap down or limit move) or the previous close is lower than the current low (signaling a potential gap up or limit move). To ensure positive numbers, absolute values were applied to differences.

Calculation:

True Range is the greatest of the following three values:

* difference between the current maximum and minimum (high and low);


* difference between the previous closing price and the current maximum;


* difference between the previous closing price and the current minimum.

The indicator of Average True Range is a moving average of values of the true range.