The Average True Range, known as ATR, is one of the several functional indicators that let forex traders know when to enter positions. Professional technical traders find it highly useful for devising an effective entry and exit approach.
We will show you how the Average true range works and how to use it to trade forex.
What is average true range?
The Average True Range is an indicator that shows the asset’s volatility level within a given time frame.
In other words, it tells you how much the price of a currency pair fluctuates. Whether it has high volatility, meaning the price makes huge swings up and down, or low volatility, where rarely fluctuates and remains somewhat stable.
High average true range implies that the currency pair’s price is making rapid shifts, and there is considerable fluctuations.
A low average true range, on the other hand, means that price fluctuation is very low.
The Average True Range indicator usually reads a low value in a range market condition or during price consolidations.
How the ATR measures volatility
The ATR indicator works by moving up and down as the price moves high and low. It then calculates the ATR value according to the time set on the price chart.
For instance, the indicator will calculate and show you a new ATR value every 10 minutes if the price chart is set at this time frame. It will show a new ATR every 24 hours if the price chart is a daily chart.
These readings form an unbroken line that runs high and or low across the chart. It tells forex traders how volatile the currency pair has been in specified periods.
2 things to note with the Average true range:
- High ATR value indicates a possible change in the ongoing trend.
- Low ATR value implies that the trend is weak.
Note that the ATR is not a trend indicator, it simply shows the volatility level of a given asset in a specified time frame.
What does ATR stand for in forex?
ATR stands for Average True Range. It is an applicable indicator that helps measure the asset’s volatility level in a specific period.
Welles Wilder came up with this concept to help traders deal successfully in the highly volatile commodity market. Although, ATR is now very popular among forex traders.
Forex traders use it to determine the best entry points and stop-loss value.
ATR indicator calculates how volatile a given forex pair is and presents the reading according to the price chart’s timeframe.
But it can also be calculated manually. Let’s take a look at how.
How to calculate the Average True Range
To compute the ATR value, you need to determine the True Range (TR) of the pair. The True Range for the given periods is then used to determine its average.
How do you find the True Range in forex?
Two things are taken into consideration when computing the TR. They are:
- The high and low price range of the most recent period.
- The closing price of the previous period.
The trader must then calculate these three values below and compare them to arrive at the true range:
The current time period’s high minus its low.
The current period’s low value minus the previous time period’s close.
The current period’s high minus the close of the previous period.
Since the ATR indicator measures volatility, not price, it does not matter if the number you arrive at is negative. The biggest absolute value for each period is the True Range, through which the ATR is then computed.
Welles Wilder, the propagator of this concept, used a 14 time period in his ATR calculation and offers this formula:
“[(Prior ATR × 13) + current TR] ÷ 14 = current ATR”
Though Welles Wilder was more focused on the commodity market when he developed this concept, the formula also works with currency trading.
Note that periods can be hourly, daily, or weekly, depending on the price charts. The trader computes the periods in hours if they use an hourly chart. For instance, 14 periods will be 14 hours. If they use a daily chart, periods will be in days. 20 periods will then mean 20 days. The same is the case for minutes price charts or any other time frame.
How do you trade with ATR in forex?
Forex traders trade with the ATR using different approaches. A few combine all listed below while using this indicator:
- Ascertain the accurate stop-loss or limit order points
- Confirm trade signals
- For forex day trading
- Determine the best exit points
Using ATR to determine the accurate stop or limit points
The ATR is known as a volatility indicator because it calculates the distance between the highs and lows in the price charts within a specified time.
It is represented in decimal numbers, showing the number of pips the asset gained and lost within the set period. A high ATR value means the volatility for that asset is high, and the price is seeing a lot of activity.
If the ATR is low, it means the price sees little activity. The difference in the pips between the periods reduces in this case.
So, when volatility for a given forex pair is high, this means higher risk. The trader then puts a tight stop loss to regulate the risk.
But if the ATR reads low, traders use a less tight stop or limit orders. There is a greater chance for a tight stop order to be executed on a highly volatile forex pair. In the same way, a small limit order is more likely to get effected on a less volatile forex pair.
Confirm trade signals
Some forex traders use ATR to determine the best exit approach in their trading. Others use it with another indicator to find the best entry point.
In this case, the ATR confirms the signal from other indicators.
For example, a technical trader may decide to enter a SELL trade based on their signals and trading approach. The trader then confirms this signal by calculating the ATR. He deems it accurate if the ATR reads high, showing an increase in the average price of the pair. The ideas is that the price is more likely to make a downturn since it has risen above its average. Therefore, a SELL trade will be the best move in this case.
For forex day trading
Forex day traders use the ATR in daily charts to set a profit target. The ATR will read higher as soon as the market opens if on a daily chart. That’s because the market is the most volatile at this time, showing higher volatility than the previous day’s closing.
After the first few minutes, volatility drops. The indicator only shows the average price moves within the chart’s time frame, whether one minute or five.
Day traders can then see how much the forex pair moves during the day. They can use a one-minute price chart, for instance, to see how the currency pair’s price moves in 3 minutes, 5, or 10 minutes.
It then helps determine where to place stop-loss or take-profit orders.
For example, the ATR indicator on a 5 minutes chart reads 0.06. This implies that the price moves around 6 cents in 5 minutes. If you predict a decrease in the price, you expect that the price can only rise 12 cents within 10 minutes. With this, you know where to place your limit orders.
Determine the best exit points using ATR
Many forex traders use the ATR to find the best point to place a trailing stop-loss order.
Trailing stop-loss orders helps the trader automatically close an unfavorable trade immediately the price starts moving against the position. But it also allows you adjust the value and change your exit points if the price moves in your favor.
Once you place a new trade, calculate the current ATR. The basic rule here is to multiply the current ATR by two, then put a trailing stop on the value.
So for a BUY position, the trailing stop-loss value should be two times the current ATR, below the price at which you entered the trade.
If the price moves are favorable for your position, you can keep adjusting the trailing stop to two times the ATR beneath the price. That is, the stop-loss moves higher in this case.
As you move the stop order up, it stays there until you move it again or the trade closes. The position will automatically close if the price drops and touches the trailing stop-loss that you’ve set.
If you place a SELL trade, the same thing happens accordingly. The stop-loss moves lower in this case, until the trade closes or until you exit the position.
For instance, assuming you enter a BUY trade at $100 and the current ATR is 0.100. You can place the trailing stop at $99.8. That’s 0.100 multiplied by 2.
If the price moves up to $100.20 and the ATR is still 0.100. You then move your trailing stop to $100. If it increases again to $100.50, the stop-loss should be moved to 100.30. The trader can continue adjusting the trailing stop like this until the price drops and the position closes. Or till they feel like exiting the trade.
What is average daily range?
The average daily range shows you how much the price of a forex pair moves on average in a day. It measures the distance between the price lows and highs within the day.
The trader can choose any number of days to determine the ADR. It can be 5-day, 10, 15, 20, etc.
Popular trading platforms come with this indicator, so the calculation is automated. But, like the ATR, the trader can compute the ADR manually.
On the MetaTrader, you will have to select ADR. If not, the indicator computes the ATR for the time frame in which it was set.
The ADR measures the volatility level of a given forex pair within the specified day. The value is represented in pips, showing the average price movement of the forex pair in pips.
A high ADR implies that the pair’s volatility for that day is higher than average.
3 possible conditions for the average daily range
- The ADR can be high when the market opens and low as it nears its closing time. Traders find bearish opportunities in this scenario.
- The ADR can be in the middle when the market opens. It can then move high and low throughout the day and close in the middle. The support and resistance zones are best traded in this scenario.
- It can be low when the market opens and climbs to move high as the market closes for the day. Traders find bullish opportunities here.
Each of these scenarios presents its trading opportunities, as we mentioned. Below, we explain the importance of the ADR to both price action and technical forex traders.
The Usefulness of the Average true range to forex traders
Find and effectively use support and resistance zones
Once the trader determines the ADR for their currency pair, they can effectively trade the support and resistance zones that appear beyond the average price. That’s because once the pair’s price has reached the ADR, it is easy to determine the reversal point and place a winning trade.
Ascertain the accurate points to place limit orders
Once a day trader knows the average daily range, they can set a stop-loss and take profit accordingly. The trader can place the appropriate limit orders in both directions using the ADR as the price is expected to move within that range.
How to calculate the ADR
As we have mentioned, popular trading platforms such as the MetaTrader fortunately usually come with this indicator. It computes the ADR automatically once the trader sets their desired time frame.
But the manual calculation is also easy to do. This is how the ADR calculation works:
For example, you need to determine the ADR for the last 5 days in January. Assuming the pips for each day are:
Jan 26th – 55 pips
Jan 27th – 45 pips
Jan 28th – 54 pips
Jan 29th – 48 pips
Jan 30th – 51 pips
Jan 31st – 47 pips
The formula here will be (Jan 26th + 27th + 28th + 29th + 30th + 31st) ÷ 5 = ADR
That is, 55 + 45 + 54 + 48 + 51 + 47 ÷ 5
This is the ADR. Thankfully, trading platforms calculate this automatically and display the value on the indicator. The information is valuable to traders. They can combine it with signals from other indicators to make the best and most profitable decisions.
Frequently Answered Questions
How do you use the average daily range indicator?
The average daily range indicator shows you how much, on average, the asset price moves on a given day. If it is high, this implies the price has moved up higher than the average. Some traders look for bearish opportunities here as they expect the price to make a downturn. If the ADR is low, there might be bullish trading opportunities since the price has moved below its daily average. Traders expect a rise to meet or surpass the daily average.
It is helpful to combine the ADR indicator with other tools, such as the RSI or Bollinger-band to confirm support and resistance areas. This strengthens the trade signal and improves the trading approach.
What is a good average true range?
The most common ADR period is 14. But other periods work just fine. Using shorter periods than this presents a more recent volatility level. Therefore, the best average true range depends on the trader’s objective.
The Average True Range is an indicator that shows how much the price is moving in a specified period. This information is valuable, especially for forex price action traders who sometimes trade blind. It is a useful price statistic that helps confirm signals from other indicators for technical traders. Whatever your trading style, knowing the average price of your chosen forex pairs at specific times is a solid foundation for placing winning trades and taking appropriate risk measures.