What Is Average True Range & How to Calculate ATR?

As a way to deal with volatility in trading, which is of particular importance when dealing with cryptocurrencies, traders often employ a variety of technical analysis and price volatility indicators such as Average True Range (ATR) to help anticipate price movements. 

But what is Average True Range? Here’s a closer look at what is ATR, ATR calculation, and how you can apply it when conducting technical analysis for cryptocurrency trading.   

In cryptocurrency trading, ATR is one of the most well-known forms of technical volatility indicators. It was created by technical analyst J. Welles Wilder Jr. in 1978 and has since become an integral part of other indicators that identify the directional movement of markets, such as Average Directional Movement Index (ADX) and Average Directional Movement Index Rating (ADXR). 

Traders utilize ATR in an attempt to determine the optimal time to trade volatile swings. 

To aid in this task, ATR calculates a market’s average price during a 14-day range. The indicator doesn't provide an indication of price trend but instead offers insight into the degree of price volatility during that time period. A high ATR indicates high price volatility during the given period, and a low ATR indicates low price volatility. 

Traders can take into account the low or high price volatilities when deciding to buy or sell an asset during the specified time period. It’s important to remember that ATR only provides an approximation of price volatility and should be used as an aid in conjunction with other indicators and metrics. 

Unsure of how to calculate average true range? The first step in calculating ATR is determining a given period’s greatest true range (TR). This requires calculating three different ranges to identify the greatest of the three. 

1. The latest period's high minus the latest period's low.
2. The absolute value (ignoring any negative sign) of the latest period's high minus the previous close price.
3. The absolute value of the latest period's low minus the previous close price.

The length of the period can vary depending on the trader’s preferences. For example, a crypto trader could look at a period of 24 hours, 14 days, or 1 month, depending on the type of trading they are doing. 

To determine the average true range over a span of time (typically 14 days), the true range is calculated for each period (day), and then all the ranges for the span are added together and divided by the number of periods to find the simple average. This is the ATR for the previous time period. 

To calculate the ATR for the current time period, you first need to identify the time periods TR. Then you use the ATR calculated in the previous step and multiply it by the length of the time period minus one (n -1). You then add that number to the TR and divide that amount by the length of the time period (n).  

[ Previous ATR (n-1) + TR ] / n

Determining the ATR in this manner allows traders to learn about the volatility of asset prices during that time. The indicator is typically displayed as a line on a trader's chart, below the price. 

In the chart above, you can see that any time the volatility increases in either price direction, the ATR line rises. 

There are great benefits to using ATR in trading. The ATR provides cryptocurrency traders with an estimate of price volatility during a time period, which can be especially useful due to the highly volatile nature of the crypto markets. ATR can give valuable insight into where to set take-profit and stop loss orders, for example. 

A common method used to determine a stop-loss is to multiply the ATR by 1.5 or 2 and then using that figure to locate how far below your entry price you should put the stop-loss. Utilizing this buffer should prevent the market from triggering your stop-loss during regular volatility, but will protect you in the event that the market experiences a spike in volatility that moves in a significant fashion against your position. 

One of the benefits of indicators like ATR is that they help locate specific levels to focus on and help eliminate market noise that may affect your trading strategy. It's important to apply the proper time span that matches your trading strategy when calculating ATR. You don’t want to be using a daily ATR to trade a suspected long-term trend. 

There are two main disadvantages that traders run into when using ATR:

1. The indicator is subjective and open to interpretation, which can be a disadvantage since no single ATR value can clearly determine if a trend will reverse or continue on. 
2. ATR only measures price volatility and provides no insight or forewarning into a change in an asset’s price direction. This can sometimes lead to mixed signals, especially when a market experiences a sudden pivot or when trends are at turning points. Traders often mistake a sudden increase in ATR as a confirmation of an old positive or negative trend, which can be a false interpretation. 

ATR is an important piece to include in any trader’s toolkit for helping to understand volatility patterns. Volatility is especially critical to consider when trading cryptocurrencies. While ATR can provide valuable insight and is a simple indicator to apply, it’s important to take note of its limitations and employ it as part of a well-rounded trading strategy.