Length : 5.00 Minutes
Average True Range (ATR)
Average True Range (ATR) is a technical indicator that measures volatility by decomposing the entire range of an asset price for that period. ATR does not provide an indication of price direction, It is an indicator used for measuring the volatility of the market at a given time.
Simply put, a currency pair experiencing a high level of volatility has relatively a higher ATR, and a low volatility pair has a lower ATR.
Below you can see the ATR reading of two different currency pairs. The first one is GBP/NZD, which is on average a very volatile pair. Notice the ATR reading of this particular pair is 0.0042, which is significantly higher than most of the other pairs. Since the period of the ATR is 14 in this case, that indicates that the average range of the previous 14 candles is 42 pips for this pair.
On the other hand, below we have a very low volatile currency pair USD/HKD. The ATR reading for this pair is only 0.0007, which indicates for the past 14 candles the average movement of this pair is only 7 pips. That is significantly lower compared to GBP/NZD, in fact USD/HKD has moved only 1/6 of GBP/NZD.
What makes the ATR so great?
ATR is a great indicator for money management. Money Management is the single most important factor in trading that all of the successful traders implement in their strategy.
The ATR helps traders to identify key levels to exit trades as it would help traders to measure volatility of an asset effectively.
To illustrate the use of ATR, once again let's compare EURUSD, with the ATR value of 0.0032 and GBPNZD, with the ATR value of 0.0084 at a given time. Taking the ATR value of these two pairs into consideration, will give an insight that GBPNZD moves 2.6 times more than EURUSD at that specific time. To put it differently GBPNZD is 2.6 times more volatile than EURUSD. Therefore, logically the stop loss on GBPNZD should be 2.6 times bigger than EURUSD, in order to withstand the market short term noises and volatility of GBPNZD.
How to utilise ATR for exit strategy and placing the stop-loss? Simple!
For Short-term trading strategies stop loss is advised to be 1.5 to 2 times of ATR value away in order for the stop loss to have enough buffer against market volatility. It is important to note, in order to measure the accurate ATR value, you always have to consider the ATR value of the previous candle, as the current floating candle is not closed yet and does not have a fixed ATR reading.
For example, If EURUSD rate is 1.1425 and the ATR value of the previous candle is 0.0033. Then, the reasonable stop loss gap for short term strategy would be 0.0049 (1.5 x 0.0033). Thus, the stop loss should be 49 pips away from the current rate. In this case the stop loss should be place at 1.1376 (1.1425-0.0049).
On the other hand, For medium and long term trading strategies you can multiply the ATR by 3 and 5 respectively to have enough buffer against market volatility in the longer time-frames.