What does Average True Range measure?
The short answer
Average True Range measures volatility and does not indicate price direction. StockCharts ChartSchool
Average True Range gives a single number that describes how much a security has typically moved, bar to bar, over a lookback window. A higher reading describes bars that covered more ground. A lower reading describes bars that covered less ground. Average True Range measures volatility and does not indicate price direction. StockCharts ChartSchool
How is Average True Range calculated?
The short answer
Average True Range is built from True Range, which is the greatest of three comparisons for a given period. The first value is a simple average of True Range, and every later value is smoothed from the prior one.
The first step is to find True Range for each period. True Range is defined as the greatest of the following: the current high minus the current low, the absolute value of the current high minus the previous close, or the absolute value of the current low minus the previous close. StockCharts ChartSchool
The second step is to average the first set of True Range values. Average True Range is typically based on 14 periods and can be calculated on intraday, daily, weekly, or monthly data. StockCharts ChartSchool
After that first average, each new reading is smoothed: the prior Average True Range is multiplied by 13, the current True Range is added, and the total is divided by 14. StockCharts ChartSchool
Because each new value is built on the one before it, earlier periods keep a small and shrinking weight in the reading rather than dropping out all at once.
Where did Average True Range come from?
The short answer
Average True Range was developed by J. Welles Wilder, who features it in his 1978 book, New Concepts in Technical Trading Systems. StockCharts ChartSchool
What does published research say?
The short answer
The sources cited here include no published test of the Average True Range.
Our sources include reviews of technical trading rules in general.
A 2007 review by Cheol-Ho Park and Scott Irwin looked at 95 modern studies of technical trading rules in general: 56 reported positive results, 20 negative results, and 19 mixed results. Despite that positive evidence, the review found that most of the studies had problems in their testing, such as data snooping and difficulty estimating risk and transaction costs, and said future research must fix them before the evidence can be called conclusive. RePEc IDEAS
A 2011 St. Louis Fed working paper by Christopher Neely and Paul Weller reviewed research on technical trading rules in general in currency markets. It reported that simple rules on dollar exchange rates gave positive returns, after accounting for risk, for 15 years in the 1970s and 1980s before those returns disappeared, and that more complex, less studied rules have since produced more modest returns. Fed in Print (Federal Reserve)
How is Average True Range commonly used?
The short answer
A given Average True Range reading describes how far a security has typically moved, in price terms, per period over the lookback window. Some people reference that reading as one piece of context when they think about stop distance, alongside the rest of their plan.
Consider a hypothetical chart where the Average True Range reading is wider than it was earlier in the same series. That wider reading describes bars that have covered more ground recently. It says nothing about where the price is headed next. In a hypothetical review, someone might note that reading next to other parts of their plan when thinking about stop distance for a position, without the reading determining any particular outcome. This example is illustrative only and does not indicate typical results.
What are the limits and common misreads?
The short answer
Average True Range does not indicate price direction, and its values are not directly comparable across different securities.
A common misread is assuming two different securities with the same Average True Range reading have similar volatility. ATR is based on absolute price changes rather than a percentage of price, so lower-priced securities tend to show lower ATR values than higher-priced securities, making ATR values not directly comparable across securities. StockCharts ChartSchool
Another common misread is treating a wide reading as a sign that price is about to move in a particular direction. Average True Range measures volatility and does not indicate price direction. StockCharts ChartSchool
Average True Range is calculated from past market data; it is not a forecast.
How is Average True Range read alongside other context?
The short answer
Average True Range adds one piece of information about how much a security has typically moved. People often look at it next to the chart itself and other context, rather than on its own.
Someone reviewing a chart might look at an Average True Range reading next to the overall shape of recent price action, areas noted on the chart such as those described in How Support and Resistance Form as Areas on a Chart, or other parts of a trading plan such as the ideas in How to Decide Your Risk Before the Market Opens. Looking at more than one piece of context does not resolve what happens next. No indicator or combination of indicators makes an outcome certain. Trading involves the risk of loss.
Take it with you
- Average True Range measures volatility and does not indicate price direction. StockCharts ChartSchool
- True Range is defined as the greatest of the following: the current high minus the current low, the absolute value of the current high minus the previous close, or the absolute value of the current low minus the previous close. StockCharts ChartSchool
- Average True Range is typically based on 14 periods and can be calculated on intraday, daily, weekly, or monthly data. StockCharts ChartSchool
- ATR is based on absolute price changes rather than a percentage of price, so lower-priced securities tend to show lower ATR values than higher-priced securities, making ATR values not directly comparable across securities. StockCharts ChartSchool
- Average True Range is calculated from past market data; it is not a forecast.
Disclosure
This article is educational content from One Purpose Trading. It is not financial, investment, tax, or legal advice, and nothing here is a recommendation to buy or sell any security or instrument.
Trading involves substantial risk of loss and is not suitable for everyone. You can lose more than your initial investment. Any examples, figures, or scenarios are illustrative only. Results are not typical, and past performance does not guarantee future results.
You are responsible for your own decisions. Trade only with capital you can afford to lose, and consider consulting a licensed professional about your individual situation.