Forex

ATR indicator

Hi there!

We are going to talk today about an indicator that was created by Welles Wilder and introduced in his well known book “New Concepts in Technical Trading Systems”; the ATR indicator.

The ATR (Average True Range) is a volatility measuring indicator hence it indicates the strength or weakness trend , so the ATR is not signal generator and will not tell you when to enter the market. But it’s very important indicator that widely used in many of strategies to indicate the best entry point when the trend warm up and it used too to indicate the best time to exit trade when the trend lose its interest.

How does the ATR work?

The normal volatility formula that uses the high and low of the given period of the calculation didn’t fit Welles’s aspirations, That’s because the gaps and limited moves in the price are effecting the accuracy of the common formula.

To overcome this issue Welles started by defining TR as the greatest of the following values:

1- Current high - Current low
2- Absolute value of current high - previous close
3- Absolute value of current low - previous close

The ATR is the moving average of the TR for the giving period (typically 14 days) - Figure 1.

It advised as a general usage of the ATR indicator that low and high records indicate a potential reversal of the trend, however the best usage of the ATR indicator is using it in trailing stop your orders.

ATR Trailing Stop:

We’ve said that the best usage of the ATR - and the volatility measuring indicators - is determining the best time to exit the trade. This based in a simple fact “When the volatility go down the trend loss its interest”.

What are the trailing stops anyway?

Trailing stop is a line of the stop points that follows your trade, when you make profit the trail stop modify you stop loss value to protect your profit and if the price drop back to the stop loss level the position will exit.

The hard coded trailing stop number doesn’t respect the movement of the price and could prevent a potential profit.

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