Average True Range (ATR)

What Is Average True Range?

The Average True Range (ATR) is a volatility indicator developed by J. Welles Wilder Jr. Unlike many indicators that measure price direction or momentum, ATR measures only the degree of price movement, or volatility. It calculates how much a security typically moves in a single period, expressed in the same units as the security's price.

The "true range" concept is important because it accounts for gaps. A security that closes at $100 and opens the next day at $103 has a gap that a simple high-low range would not capture. The true range formula uses the previous close as a reference point to ensure gaps are included in the volatility measurement.

How Traders Use ATR

Stop-loss placement is ATR's most practical application. Rather than using arbitrary fixed stops ($1, 2%, etc.), ATR-based stops scale with current volatility. A stop at 2x ATR gives the trade room to breathe during normal fluctuations while protecting against unusual moves. This approach prevents the common problem of stops that are too tight in volatile markets (causing unnecessary exits) or too wide in calm markets (risking too much capital).

Position sizing uses ATR to normalize risk across different securities. By allocating a fixed dollar risk amount and dividing it by the ATR-based stop distance, traders can take positions that represent equal risk regardless of the stock's price or volatility. A volatile $20 stock and a stable $200 stock can be sized to represent the same dollar risk per trade.

Volatility filtering uses ATR to identify when markets are unusually quiet or active. Low ATR readings (relative to history) suggest consolidation that often precedes a breakout. High ATR readings indicate active trending or panic conditions where larger moves are normal and expected.

ATR in Trading Systems

Many systematic trading strategies use ATR as a core component. The famous Turtle Trading system used ATR (called "N") for both position sizing and stop placement. Trailing stops based on ATR, such as the chandelier exit (highest high minus 3x ATR), adapt to market conditions automatically, giving trends room to run while protecting profits.