The Average True Range (ATR) is a technical indicator used in the forex market to measure volatility. It was developed by J. Welles Wilder Jr. and is a popular tool among traders to determine the size of a trade and set stop-loss orders. In this article, we will explain how to use the ATR forex indicator to improve your trading decisions.
Understanding ATR
The ATR is a measure of the price range over a specified period. It is calculated by taking the average of the true range over a certain number of periods. The true range is the largest of the following:
1. The difference between the current high and the current low.
2. The difference between the previous close and the current high.
3. The difference between the previous close and the current low.
The ATR is expressed in pips or points and is represented as a line on the price chart. The higher the ATR value, the more volatile the market is.
Using ATR to set Stop Loss
One of the most common uses of ATR is to set stop-loss orders. A stop-loss order is an order to close a trade at a predetermined price if the market moves against you. The ATR helps you to determine the appropriate stop-loss level based on the volatility of the market.
To use ATR to set stop-loss, you need to first calculate the ATR value for the currency pair you are trading. For example, if you are trading the EUR/USD pair on a daily chart, you may use a 14-period ATR to calculate the average true range. If the ATR value is 100 pips, you can set your stop-loss at 2 times the ATR value, which is 200 pips. This means that if the market moves against you by 200 pips, your stop-loss order will be triggered, and your trade will be closed automatically.
Using ATR to determine position size
Another way to use ATR in forex trading is to determine the appropriate position size based on the volatility of the market. The ATR can help you to determine the size of your trade based on your risk tolerance and the volatility of the market.
To use ATR to determine position size, you need to first calculate the ATR value for the currency pair you are trading. For example, if you are trading the GBP/USD pair on a daily chart, you may use a 14-period ATR to calculate the average true range. If the ATR value is 150 pips, you may decide to risk 1% of your account per trade. This means that you can risk 1% of your account on a trade that has a stop-loss of 150 pips.
Using ATR to confirm trend
Another way to use ATR in forex trading is to confirm the trend. ATR can help you to determine whether the market is trending or ranging. If the ATR value is high, it indicates that the market is volatile, and there is a strong trend. If the ATR value is low, it indicates that the market is ranging, and there is no clear direction.
To use ATR to confirm trend, you need to first calculate the ATR value for the currency pair you are trading. For example, if you are trading the USD/JPY pair on a daily chart, you may use a 14-period ATR to calculate the average true range. If the ATR value is 50 pips, and the price is moving in a narrow range, it indicates that the market is ranging. However, if the ATR value is 100 pips, and the price is moving in a clear direction, it indicates that the market is trending.
Conclusion
The ATR is a powerful technical indicator that can help you to improve your trading decisions. It can help you to set stop-loss orders, determine position size, and confirm the trend. However, it is important to note that the ATR should not be used in isolation. It should be used in combination with other technical indicators and fundamental analysis to make informed trading decisions.
