What Is Average True Range?
ATR measures average daily price movement to quantify volatility. Traders use it to set stop losses, size positions, and compare volatility across different stocks.
Definition
Average True Range (ATR) was developed by J. Welles Wilder (same creator as RSI) to measure market volatility. The 'true range' for each day is the greatest of: today's high minus today's low, today's high minus yesterday's close, or today's low minus yesterday's close. ATR averages these true ranges over 14 periods by default.
A higher ATR means the stock moves more day to day — it's more volatile. A lower ATR means quieter, more range-bound trading. ATR is expressed in dollars (or points), not percentages, so comparing ATRs between different-priced stocks requires converting to percentage terms.
The primary use of ATR is position sizing and stop loss placement. Traders often set stops at 1.5x or 2x ATR below entry, ensuring the stop is outside normal price noise. If ATR is $3 and you set a stop $0.50 below entry, you'll get stopped out constantly by random fluctuations.
Real-World Example
A $100 stock has an ATR of $2.50 — it moves an average of $2.50 per day. A trader buying this stock sets a stop loss 2x ATR ($5) below their $100 entry at $95. Position size is calculated so that if the stop is hit, the loss equals 1% of total portfolio — a classic ATR-based risk management approach.
Why It Matters
ATR-based stop losses and position sizing are the foundation of professional risk management — they adapt to the stock's actual volatility rather than arbitrary dollar amounts that may be too tight or too loose.
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Frequently Asked Questions
How do I use ATR to set a stop loss?
Multiply the ATR by a factor (1.5x to 3x depending on your risk tolerance) and subtract from your entry price for a long trade. A tighter stop (1.5x ATR) gets stopped out more often but limits losses. A wider stop (3x ATR) survives more noise but risks larger losses per trade.
What is a good ATR for a stock I want to trade?
It depends on your trading style. Day traders prefer higher ATR stocks (more movement = more opportunity). Swing traders are comfortable with moderate ATR. For a $100 stock, a 1-2% daily ATR (1-2 points) is moderate; 3-5% is high volatility. Match ATR to your position size and risk tolerance.
How does ATR relate to Bollinger Bands?
Both measure volatility. ATR uses the true range (including gaps); Bollinger Bands use standard deviation of closing prices. ATR is better for stop loss placement; Bollinger Bands are better for identifying relative price levels and squeezes. Many traders use both together.
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