What Is Average True Range (ATR)?
In quantitative finance, ATR stands for Average True Range. It’s another popular technical indicator used in algorithmic trading to measure volatility in the market. Developed by J. Welles Wilder, Jr., ATR is calculated based on the true range of price movement over a specified period.
The true range is the greatest of the following:
The difference between the current high and the current low.
The difference between the previous close and the current high.
The difference between the previous close and the current low.
ATR is then calculated as the average of these true ranges over the specified period, typically 14 periods.
In algorithmic trading, ATR has several applications:
Volatility Measurement: ATR provides a measure of market volatility. Higher ATR values indicate higher volatility, while lower values suggest lower volatility.
Setting stop loss and Take Profit Levels: Traders can use ATR to set dynamic stop loss and take profit levels based on the current volatility of the market. For example, they may set stop losses a certain number of ATR units away from the entry price to account for market fluctuations.
Position sizing: ATR can be used to adjust position sizes based on market volatility. In highly volatile markets, traders may reduce their position sizes to manage risk, while in low volatility markets, they may increase position sizes to take advantage of potential larger moves.
Filtering Trades: Some trading strategies use ATR as a filter to only take trades when volatility is above or below a certain threshold. This helps traders avoid entering trades in excessively volatile or quiet market conditions.
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