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How to Use Average True Range Indicator (ATR) in Forex Trading

How to Use Average True Range Indicator (ATR) in Forex Trading 

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The Average True Range Indicator (ATR) is a popular technical analysis tool widely used for measuring market volatility. It was introduced in 1978 by the renowned trader and analyst Welles Wilder. The ATR is commonly used in forex analysis to measure how much an asset moves on average in a given time frame. If you’re wondering what an Average True Range Indicator (ATR) is and how it helps you trade better; this article is for you! 

Forex Trading with Average True Range Indicator (ATR): Key Takeaways

There are several benefits that forex traders can derive from using the ATR indicator: 

1. Predicting volatility: The ATR indicator is often used by forex traders to predict the potential volatility of a currency pair.  

2. Determine position size: By knowing the volatility of a currency pair, traders can use the ATR to estimate the appropriate position size to take on a trade. 

3. Risk management: The ATR indicator can be used to set stop-loss orders at safe distances from entry points, depending on how volatile the currency pair is. 

4. Trend identification: ATR is also capable of identifying market trends. Increasing ATR values indicate an increasing trend while decreasing ATR values indicate a decreasing trend. 

5. Trend confirmation: ATR can also be used to confirm the strength of a trend. High ATR values may indicate a strong, long-term trend and a low, falling ATR value suggests a weak trend. 

What Is the Average True Range (ATR)? 

The Average True Range (ATR) is a technical analysis indicator that measures the volatility of a financial instrument over a specified time period. It is calculated as the average of the true range values over a certain period of time. 

How to Use Average True Range Indicator (ATR) in Forex Trading 

The true range is the highest of the following three values: 

  • Difference between the current period’s high and the current period’s low 
  • Difference between the current period’s high and the previous period’s close 
  • Difference between the current period’s low and the previous period’s close 

The Average True Range Indicator (ATR) oscillates up and down as price movements in an asset increase or decrease. With each passing period, the ATR is calculated anew. In a one-minute chart, the ATR is calculated every minute. For a daily chart, an ATR is calculated every day. On a graph, all the readings are plotted as a continuous line, allowing traders to observe how the volatility of the financial instrument has changed over time. 

The Average True Range Indicator (ATR) was introduced to the financial market by market technician J. Welles Wilder Jr. in his book "New Concepts in Technical Trading Systems" as a method of assessing market volatility by analyzing the entire price range of an asset over time. Traders use the ATR indicator in combination with other technical indicators to help them make informed decisions about their trades. 

How to Read the Average True Range (ATR)? 

The Average True Range Indicator (ATR) is typically displayed as a single line on a chart in which the line moves up and down. Reading the ATR indicator is very simple: higher ATRs indicate increased volatility, while lower ATRs indicate decreased volatility. In this case, the ATR values are measured in pips. 

How to Use Average True Range Indicator (ATR) in Forex Trading

Here are a few ways to understand the Average True Range Indicator (ATR) much better: 

  • Range expansion: If the ATR value increases, it may indicate that the range of price movements for the financial instrument is expanding. An indication of this could be the beginning of a trend change or a break from the current trend. 
  • Range contraction: If the ATR value decreases, it may indicate that the range of price movements for the financial instrument is contracting. Possibly, this indicates that the current trend is weakening and may be coming to an end. 
  • Trend confirmation: Traders can also use ATR to confirm the strength of a trend. If the ATR value is high and rising, it may indicate that the trend is strong and likely to continue. If the ATR value is low and falling, it may indicate that the trend is weak and is unlikely to continue. 

It is important to note that the Average True Range Indicator (ATR) must be used in conjunction with other technical indicators and analysis tools since it only indicates volatility and not price direction. 

How to Calculate Average True Range? 

To calculate the Average True Range Indicator (ATR), you will need to first calculate the true range for a given period, and then calculate the average of the true range values over a specified number of periods. 

True Range includes both the current period’s high and low ranges and the previous period’s closing price (if needed). 

Here is the formula for calculating the true range: 

True Range = max [(high – low), abs (high – previous close), abs (low – previous close) 

To put it in broader terms,  

True Range = Max (current period’s high – current period’s low, absolute value of current period’s high – previous period’s close, the absolute value of current period’s low – previous period’s close) 

The absolute value is used since the ATR doesn’t measure price direction, just volatility. That means there can’t be any negative numbers. 

Average True Range Indicator (ATR) is calculated by taking the average of the true ranges for a given number of periods. For example, to calculate the 14-period ATR, you would need to take the average of the true ranges for the past 14 periods. 

Here is the formula for calculating the ATR: 

Current ATR = ((Prior ATR x 13) + Current TR) / 14 

To put it in broader terms, 

Current ATR = (previous ATR x (periods – 1) + current period’s true range) / periods 

Average True Range Indicators are typically based on daily price data, so the periods in the formula above would typically represent days. The ATR can be calculated using any timeframe, such as weekly, monthly, or hourly. 

For example, let's say USD/JPY hits a high of 115.73 and a low of 115.32 in today's session, after previously closing at 115.98. 

*115.73 - 115.32 = 41 
*115.73 - 115.98 = -.25 
*115.32 - 115.98 = -.73 

Among the three figures, -.73 is the greatest. Therefore, the current true range can be calculated by subtracting the high from the low. 

By default, the ATR indicator displays a moving average of the last 14 sessions. Just like most indicators, it can be customized to include as many sessions as the trader wishes. Traders who trade short-term often use ATRs of ten sessions or fewer.

Role of Average True Range Indicator (ATR) in Forex Trading 

The Average True Range Indicator (ATR) can provide several benefits to forex traders. Some of the key benefits include: 

  1. Improved risk management: By understanding the volatility of currency pairs, forex traders can determine a stop loss level that is appropriate for their trading strategy. A stop-loss order limits the probability of losing on a trade by selling a currency pair at a given price. By setting a stop-loss order at a level that is appropriate for the level of volatility of the currency pair, traders can manage their risk and protect their capital. 
  1. Confirmed trends: As mentioned earlier, the ATR can be used to confirm trends in the market. Since ATR gives traders a quick snapshot of how much a market moves on a given day, traders can use it to decide whether to trade a signal provided by another indicator. If the ATR is increasing, it may indicate that a trend reversal is imminent, while a decreasing ATR may indicate that a trend is continuing. 
  1. Enhanced trade planning: Trading with the Average True Range Indicator (ATR) allows traders to take advantage of the volatility of currency pairs to plan their trades more efficiently. By using the ATR to identify potential entry and exit points, traders can improve the timing of their trades and potentially increase their chances of success. 
  1. Determine position size: Traders can use the Average True Range Indicator (ATR) to determine the appropriate position size to take on trade by understanding the volatility of the currency pair. As a result, traders can manage risk and ensure that their account is not overexposed to the risk of loss. 
  1. Better understanding of market conditions: Forex traders can also use the ATR indicator to get a better understanding of current market conditions and how volatile a currency pair will be. Traders who are interested in making informed trading decisions can find this information very useful. 

Average True Range Indicator (ATR) values can be easily interpreted by using a simple and straightforward method. Trading markets fluctuate from periods of high volatility to periods of low volatility, and ATR can help traders to keep track of these changes as soon as they occur.


Best ATR Indicator Combinations for Forex Trading 

Average True Range Indicator Forex Education

There are many different technical indicators that can be used in combination with the Average True Range Indicator (ATR) to help forex traders make informed trading decisions. Some of the best ATR indicator combinations include: 

ATR and Moving Averages 

By combining the Average True Range (ATR) Indicator with moving averages, such as the simple moving average (SMA) or the exponential moving average (EMA), traders can identify trends and determine their strengths. If the ATR is increasing while the moving average is trending upward, it may be a sign of a strong uptrend. On the other hand, if the ATR is decreasing while the moving average is trending downward, it may be a sign of a strong downtrend. 

ATR and Stochastic Oscillator 

Forex stochastic indicator is ideal for trading ranging markets because they deliver overbought and oversold signals. The ATR helps qualify ranging markets and avoid whipsaw signals that can be generated by Stochastics in non-ranging markets. Low ATR values confirm ranging markets and buy/sell signals can be provided by Stochastics crossovers in overbought and oversold zones.  

With the Average True Range Indicator (ATR) combined with oscillators, traders can also gain insight into market momentum and identify potential reversals. 

ATR and Parabolic SAR 

Parabolic SAR indicator has the advantage of being viable for trading trending markets. Combining the Average True Range Indicator (ATR) with the Parabolic SAR indicator helps forex traders establish clear-cut stop loss and take-profit price levels that will allow them to maximize their profits while minimizing risk exposure.  

If the ATR is increasing while the Parabolic SAR is indicating a trend reversal, it may be a sign that the trend reversal is likely to occur. On the other hand, if the ATR is decreasing while the Parabolic SAR is indicating a trend continuation, it may be a sign that the trend is likely to continue. 

ATR and Chart Patterns  

The Average True Range indicator (ATR) can be used in combination with Chart patterns to help traders get a sense of the volatility of the market and the potential for a trend reversal. For example, if the ATR is increasing while a head and shoulders chart pattern is forming, it may be a sign that the market is becoming more volatile, and a trend reversal is imminent.  

On the other hand, if the ATR is decreasing while a double bottom chart pattern is forming, it may be a sign that the market is becoming less volatile and the trend is likely to continue. 

ATR and Trend Lines 

Forex traders can also use the Average True Range indicator (ATR) with trend lines to determine the strength of a trend. If the ATR is increasing while the price is trending along a strong trend line, it may be a sign of a strong trend. This is because an increasing ATR can indicate that the market is becoming more volatile, which could be a sign of increased buying or selling pressure.  

Conversely, if the ATR is decreasing while the price is trending along a weak trend line, it may be a sign of a weakening trend. This is because a decreasing ATR can indicate that the market is becoming less volatile, which could be a sign of a lack of buying or selling pressure.


Using ATR for Forex Day Trading: Is it a good idea? 

The Average True Range Indicator (ATR) can be a useful tool for day traders, as it is a measure of volatility and can help traders identify potential breakout opportunities. However, it’s important to keep in mind that the ATR should be used in conjunction with other technical analysis tools and should not be relied upon exclusively. 

Forex day trading involves taking advantage of short-term price movements, and the Average True Range Indicator (ATR) can be used to help identify periods of high or low volatility. For example, a trader may use the ATR to set stop loss levels or to identify potential entry or exit points for trades. 

On an intraday chart such as a one- or five-minute chart, the ATR spikes higher when the market opens. It's because the open represents the most volatile time of the day, and the ATR represents the volatility that was present yesterday. As soon as the ATR spikes at the open, it declines throughout the day. Throughout the day, the Average True Range Indicator (ATR) doesn't provide much information except for how much the price moves on average each minute.

The one-minute ATR can be used by day traders to estimate how much an asset could move in five or ten minutes, much like they use the daily ATR. Establishing profit targets or stop-loss orders may be easier with this strategy.  

The ATR can be a useful tool for day traders, but it must be integrated into a comprehensive trading strategy that includes other technical analysis tools and risk management strategies.


Limitations of Average True Range Indicator (ATR) 

Like any other forex technical analysis tool, the Average True Range indicator (ATR) has its own set of limitations. Here are a few potential limitations of the ATR: 

  1. It is a lagging indicator: The ATR indicator draws its data from past price data, which makes it unreliable at predicting future price movements. Indicators like this are more useful as confirmation tools rather than as leading indicators. 
  1. It is sensitive to price changes: The ATR is based on the difference between the high and low prices of a security over a given period of time. This means that it is sensitive to price changes and may not provide a complete picture of market conditions. 
  1. It may produce false signals: The ATR can produce false signals in ranging or sideways markets, as it is based on price movements. This can lead to incorrect trade decisions if the ATR is used in isolation. 
  1. It does not take into account market fundamentals: The ATR is a purely technical indicator and does not take into account market fundamentals, such as economic news or earnings reports. This means that it may not accurately reflect the underlying drivers of price movements. 

Overall, it’s important to use the Average True Range Indicator (ATR) as part of a comprehensive trading strategy that includes other technical analysis tools and takes into account market fundamentals. It’s also important to practice risk management when trading and to be aware of the limitations of any indicator.


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Average True Range Indicator (ATR) – FAQ 

How do you use the ATR indicator for profit? 

Using the Average True Range Indicator (ATR) can be profitable in several ways. A simple way to open a position is when the price moves more than 1 ATR from the previous session’s closing price. Typically, when the price moves more than 1 ATR it indicates that volatility has changed, and the asset will continue to move in the same direction. Any trader can use the ATR in any time frame, from 1 minute to 1 month. 

How do you read ATR indicators in forex? 

ATR indicator values are straightforward and easy to understand. Trend changes are more likely to occur when the indicator value is higher. As the indicator’s value decreases, the trend’s movement weakens. In Forex Trading, the Average True Range Indicator (ATR) values are measured in pips. 

Which forex indicator works best with ATR? 

There isn’t a single “best” forex indicator to use with the ATR. Different indicators can be used in combination to make more informed decisions. Some best indicators include Moving averages, Bollinger bands, RSI, and MACD. It’s also a good idea to use a combination of indicators to provide multiple points of confirmation for trades.

Is ATR a leading or lagging indicator? 

The ATR (Average True Range) is a lagging indicator. This means that it is based on past price data and is not used to predict future price movements. Lagging indicators are often used to confirm trends or to provide additional information about market conditions. It’s important to note that no indicator is perfect, and all indicators have their limitations. The ATR can be an excellent tool when used in conjunction with other technical analysis tools.

How much ATR is good? 

It’s the best option to target 80 pips since it falls within the daily ATR value (and offers more than 30 pips). However, there is no specific “good” or “bad” ATR value, and traders may use the ATR in different ways, depending on their trading style and the market conditions. The Average True Range Indicator (ATR) values can be used as a reference point for setting stop-loss levels or for identifying potential breakout opportunities. 

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