Rolf Indicators , Price Action , Technical Analysis , Tradeciety Academy 4 Comments 17, Views. The ATR is a very popular trading indicator but I see often that many traders interpret or use the ATR incorrectly.

With this guide I want to help create more clarity around this useful indicator and show you how it can help your trading. During a move up, it measures the distance between the previous close and the current high of a candle left.

The ATR indicator measures volatility. Traders often mistakenly believe that volatility equals bullishness or bearishness. Volatility does not say anything about the trend strength or the trend direction, but it tells you how much price fluctuates.

In a high volatility environment, price candles usually have long wicks, you can see a mix of bearish and bullish candles, and their candle body is relatively small compared to the wicks. Momentum describes the trend strength into one direction. In a high momentum environment, you typically see only one color of candles very few candles moving against the trend and small candle wicks.

The screenshot below shows the differences. The ATR measures volatility, while the RSI measures momentum: Being able to understand which type of market you are looking at, can help you make much better trading decisions.

Understanding volatility is important to make the right trading decisions as we will see later. Understanding how volatility changes with market context can help you make much better trading decisions as well. The screenshot below illustrates how volatility changes significantly during different market periods.

Whereas volatility is low and decreasing during uptrends when price is above the moving average , volatility rises significantly when prices are falling and are below the moving average.

This market behavior is also observable in the stock market and the screenshot below shows the DAX. Again, volatility picks up significantly once price entered a downtrend and dipped through the moving average.

During the uptrends, there is significantly less volatility.

Often, a change in volatility can even foreshadow a trend change and signal the origin of new trends. Now it is obvious why it pays to know the overall market direction and the higher time-frame status. Most traders trade on the lower timeframes and quickly forget what they have seen on the higher time-frame after having done their multiple time-frame analysis.

The DATR is the Daily Average True Range Indicator and it only measures the volatility on the daily time-frame. The screenshot below shows that the DATR went down all the way while the ATR on the lower time-frame moved in waves. However, all lower time-frame ATR volatility-spikes were very short-lived.

Best Short Term Trading Strategies - Average True Range Indicator

This shows that knowing the overall higher time-frame situation is critical to understand what to expect on the lower time-frames. The ATR not only provides information about the current market state, but it is also a tool that can be used to make trading decisions.

Especially when it comes to stop loss, take profit and trade exit improvements , the ATR can be of great help. The most common use for the ATR indicator is to use it as a stop loss tool.

Basically, when the ATR is high, a trader expects wider price movements and, thus, he would set his stop loss order further away to avoid getting stopped out prematurely. On the other hand, we would use a smaller stop loss when volatility is low. The screenshot below shows a chart with the volatility stop indicator — the green dots below and above price. The volatility stop is an equivalent to the ATR stop loss strategy.

The volatility stop adjusts your stop placement based on price volatility.

It keeps you in trades during trending phases and gets you out of trades during larger retracements. In a range-environment, the volatility stop does not work as well. Adding a moving average to the volatility stop is an additional way to make sense of your price data.

The ATR also helps you understand the profit potential of your trades. Whereas you should aim for a closer take profit in a low volatility environment, setting your take profit order further away when volatility is high, can improve your trading.

As we have seen, in a high volatility market the volatility stop would lead to a larger stop loss distance. To offset a wider stop loss, the ATR will also tell you to aim for a larger take profit when volatility is high.

Thus, a trader does not reduce his reward-risk ratio by only adjusting his stop loss. The ATR is a great tool when it comes to adjusting and adapting to changing market conditions. But it can also be a great indicator to anticipate market turns once a significant change in volatility is observable.

Most traders experience inconsistent results which is often the result of an inflexible trading approach. The volatility stop and the adjusted take profit placement can help you overcome those problems. Together with the volatility behavior of the higher time-frames and the differences between uptrends and downtrends, the ATR makes for a universal trading tool.

Hello, thanks for the great article. Can I ask you which formula which use for this purpose? Can I request you share the formula used by you? Could you please give exact definitions of these terms in plain English? If you are on the daily, the lower timeframe is for example the 4H or 1H.

The higher timeframe would be the weekly for example. Now this is in line with my understanding after reading more of your articles. Lower timeframe means shorter term i. Despite that their names are a little bit confusing, they are definitely great concepts in technical analysis.

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How To Use The ATR Indicator - The Universal Trading Tool

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