ATR — Average True Range

What Is the Average True Range?

The Average True Range (ATR) is a volatility indicator created by J. Welles Wilder Jr. and introduced in his 1978 book New Concepts in Technical Trading Systems. Unlike most indicators that attempt to predict price direction, ATR measures only the degree of price movement. It tells you how much an asset typically moves over a given period, regardless of whether it moves up or down.

ATR calculates the "true range" of each bar, which accounts for gaps between sessions, and then averages those values over a lookback period (typically 14 bars). The result is a single number expressed in the same units as the asset's price. If a stock has an ATR of $3.50, it means the stock moves an average of $3.50 per bar. This information is essential for setting stop-losses, sizing positions, and evaluating whether a breakout is significant.

True Range and the ATR Formula

The True Range is the largest of three values calculated for each bar: (1) the current high minus the current low, (2) the absolute value of the current high minus the previous close, and (3) the absolute value of the current low minus the previous close. By including the previous close, the True Range captures overnight gaps that a simple high-low range would miss.

True Range = MAX of:
Current High - Current Low
|Current High - Previous Close|
|Current Low - Previous Close|

The ATR is then the moving average of the True Range over the selected period. Wilder used a smoothed (exponential-style) average: ATR = ((Previous ATR x 13) + Current TR) / 14. This makes ATR responsive to recent volatility changes while filtering out single-bar noise.

ATR-Based Stop-Loss Placement

The most practical application of ATR is setting stop-loss levels that adapt to current market volatility. Instead of using a fixed dollar amount or percentage, you multiply the ATR by a factor (typically 1.5 to 3) and place your stop that distance from your entry price. This approach ensures your stop is far enough from normal price noise to avoid premature exits, but close enough to protect you from genuine adverse moves.

For swing trades on daily charts, a 2x ATR stop is a common starting point. If a stock's 14-period ATR is $2.00, your stop would be $4.00 below your entry for a long trade. In highly volatile markets or with wider timeframes, a 3x ATR stop gives more room. For tighter day trading setups, 1.5x ATR often provides sufficient buffer. The key advantage is that this method automatically adjusts: quiet stocks get tight stops, volatile stocks get wider stops.

ATR-based trailing stops work the same way. As price moves in your favor, you trail the stop at a fixed ATR multiple below the highest close (for longs). This is essentially what the Parabolic SAR does, and many professional traders prefer ATR trailing stops for their simplicity and effectiveness.

ATR-Based Position Sizing

Consistent risk management requires adjusting your position size based on how volatile the asset is. The formula is straightforward: Position Size = Risk Amount / (ATR x Multiplier). If you risk $500 per trade and the stock's ATR is $1.50 with a 2x multiplier, your position is $500 / $3.00 = 166 shares.

This equalizes risk across different assets. A $200 biotech stock with ATR of $8.00 and a $50 utility stock with ATR of $0.80 will both expose you to the same dollar risk when properly sized. Without ATR-based sizing, the biotech position could be ten times riskier than the utility position, even with identical dollar allocations.

Common Mistakes

Using ATR for direction. ATR does not tell you whether price will go up or down. A rising ATR simply means price swings are getting larger. This could happen during a powerful rally, a sharp selloff, or a volatile consolidation. Always pair ATR with a directional indicator like moving averages or RSI.

Using a fixed stop for all stocks. A $2.00 stop makes sense for a $40 stock with ATR of $1.00, but is dangerously tight for a $150 stock with ATR of $5.00. ATR-based stops eliminate this problem by adapting to each stock's volatility profile.

Ignoring ATR expansion/contraction cycles. Volatility is mean-reverting. Periods of low ATR are typically followed by expansion (breakouts), and periods of high ATR eventually contract. When ATR is at multi-month lows, prepare for a significant move. When ATR is spiking, expect volatility to eventually calm down.

Not adjusting for timeframe. ATR on a 5-minute chart and ATR on a daily chart produce very different values. A daily ATR of $3.00 does not mean price moves $3.00 every five minutes. Always match your ATR timeframe to your trading timeframe.

Frequently Asked Questions

Related Indicators

Related Tools & Guides

Part of our Technical Analysis Guide