Average True Range is one of popular indicators used in Forex and binary options. It was developed by J. Welles Wilder in his 1978 book, New Concepts in Technical Trading Systems. This book also includes the Parabolic SAR, RSI and the Directional Movement Concept (ADX). Despite being developed before the computer age, Wilder’s indicators have stood the test of time and remain extremely popular.
Average true range (ATR) helps measuring market volatility. Multiple ATR are often used to improve trading strategies. Originally, Wilder designed ATR for commodities and assets and later it was adopted to binary contacts. Wilder created Average True Range to capture this “missing” volatility. It is important to remember that ATR does not provide an indication of price direction, just volatility. This indicator is used to identify potential breakout signals or as a base to define trailing stop-loss orders.
How to set up ATR in your Pocket Option trading account?
To activate ATR on your screen in the Pocket Option account, go to the “Indicators” menu and select the indicator. The average true range indicator looks like a single line in a section under your chart and the line can move up or down. Reading the ATR indicator is not complicated: a higher ATR means increased volatility, while a lower ATR signals lower volatility. However, remember that ATR does not give signals about the potential trend direction – it only shows what is happening with the price volatility.
As a volatility indicator, ATR doesn’t take into account the price direction. Instead, it examines how much the price of an underlying asset moves during a specific time frame and whether there are price gaps. For an hourly time frame, the ATR indicator value is calculated for each hour. On a daily time frame, the calculation is performed for each day, and so on.
According to Wilder, the average true range indicator formula is centered around the calculation of true ranges for the specific period. It is based on three simple methods:
- The difference between the current high and the previous close;
- The difference between the current low and the previous close;
- The difference between the current high and the current low.
The true range for the selected period is obtained as the highest value from the above three methods. As the absolute value is considered, it doesn’t matter whether it is positive or negative. The average value is derived from the values for each period, which, by default, is 14 periods. Wilder smoothed the generated value for a 14-period ATR using the previous ATR value. Traditional recommended parameters are 14 periods on timeframes up to H4. In the case of long trading, you can try 7 periods.
How to trade Average True Range?
First of all, you should remember that ATR does not give you a signal to buy or sell a contract. It only indicates increasing or decreasing market volatility. Depending on your trading strategy, you can change the number of periods included in the ATR calculation. Shorter time frames will provide more signals, while longer time frames will provide fewer trading alerts.
If ATR line crossed middle level trending down, it means that the activity on the market is slowing down so the volatility decreases. On the contrary, when the line is tending up, it means the price is gaining momentum.
Average True Range is an excellent technical indicator, but it has rather limited functionality. You need to use it in addition to other tools to be able to make an informed decision.
Many experienced traders use ATR in combination with other oscillators for example Parabolic SAR which generates a signal to buy a contract (a candlestick break out), and the Average True Range will confirm the direction and volatility.
In conclusion, let’s reiterate three important points. First of all, ATR is not a directional indicator like MACD or RSI, but rather a unique volatility indicator that reflects the degree of interest or disinterest in a move. Strong moves, in either direction, are often accompanied by large ranges, or large True Ranges. This is especially true at the beginning of a move. Uninspiring moves can be accompanied by relatively narrow ranges. Secondly, ATR can be used to validate the enthusiasm behind a move or breakout. A bullish reversal with an increase in ATR would show strong buying pressure and reinforce the reversal. A bearish support break with an increase in ATR would show strong selling pressure and reinforce the support break. And finally, The Average True Range indicator can be used in scans to weed out securities with extremely high volatility.
