The Average True Range (ATR) is a technical indicator used by forex traders to measure market volatility. It was developed by J. Welles Wilder in the 1970s and has since become a popular tool for traders. The ATR measures the average range of price movements in a given time period, taking into account gaps and limit moves. In this article, we will explain what the ATR is and how it works.
What is ATR?
The ATR is a measure of volatility that takes into account the gap and limit moves that occur in the forex market. It is calculated by taking the average of the true range over a given period. The true range is the greatest of the following:
1. The high of the current period minus the low of the current period.
2. The absolute value of the high of the current period minus the close of the previous period.
3. The absolute value of the low of the current period minus the close of the previous period.
The ATR is expressed in the same units as the price of the currency pair being analyzed. For example, if the ATR is 0.0020 for EUR/USD, it means that the average daily range of price movements for EUR/USD is 20 pips.
How does ATR work?
The ATR is used to identify potential changes in market volatility. When the ATR is high, it means that the market is volatile, and there is a greater chance that prices will move significantly in either direction. When the ATR is low, it means that the market is less volatile, and prices are more likely to remain stable.
Traders use the ATR to set stop-loss orders and take-profit orders. A stop-loss order is an order to sell a currency pair when the price falls below a certain level. A take-profit order is an order to sell a currency pair when the price rises above a certain level. Traders may use the ATR to set the distance between the stop-loss and take-profit levels. For example, if the ATR is 0.0020 for EUR/USD, a trader may set a stop-loss 20 pips below the entry price and a take-profit 40 pips above the entry price.
The ATR can also be used to identify potential breakouts. When the ATR is high, it means that the market is volatile, and there is a greater chance that prices will break out of a range. Traders may use the ATR to identify key support and resistance levels and look for potential breakouts.
Finally, the ATR can be used to compare the volatility of different currency pairs. Traders may use the ATR to identify currency pairs that are more or less volatile than others. For example, if the ATR for EUR/USD is higher than the ATR for USD/JPY, it means that EUR/USD is more volatile than USD/JPY.
Conclusion
In conclusion, the ATR is a useful tool for forex traders to measure market volatility. It takes into account gap and limit moves and calculates the average range of price movements over a given period. Traders use the ATR to set stop-loss and take-profit orders, identify potential breakouts, and compare the volatility of different currency pairs. While the ATR is a valuable tool, it should be used in conjunction with other technical indicators and fundamental analysis to make informed trading decisions.
