ATR (average true range)

Average true range was introduced by J. Welles Wilder in his 1978 book on technical trading systems. It answers a simple question: how much does this market usually move in one bar of the chosen timeframe?

How it is calculated

For each bar, the true range is the largest of three values:

• the current high minus the current low;
• the current high minus the previous close (as an absolute value);
• the current low minus the previous close (as an absolute value).

Using the previous close captures gaps that a simple high-low range would miss. The ATR is then a smoothed average of the true range, most commonly over 14 periods.

Worked example

Suppose the 14-day ATR on GBP/USD is 0.0090, or 90 pips. That means the pair has, on average, covered about 90 pips per day over the last 14 days. A trader who places a stop-loss 15 pips from entry on a daily-chart idea is inside normal daily noise; a stop of 1.5 times ATR (about 135 pips) sits outside it, but needs a smaller position to keep the money at risk the same.

Common uses and limits

• Setting stop distances relative to current volatility rather than a fixed number of pips.
• Adjusting position size so each trade risks a similar amount as volatility changes.
• Spotting when a market has gone unusually quiet or unusually active.

ATR is backward-looking. A quiet fortnight can be followed by a central bank surprise, and ATR will only catch up afterwards. See where to put a stop-loss for how ATR-based stops work in practice.