What is ATR
ATR is an abbreviation for Average True Range. ATR is a volatility indicator. It shows how the price changes over a certain period of time. It is not used to determine the direction of movement, the strength of growth, overbought or oversold. This tool shows how the price of a particular cryptocurrency has behaved statistically, enabling the trader to make certain investment decisions.
In most cases, the indicator is an auxiliary to limit losses. It is quite convenient to limit your risks through it by placing stop orders, in particular stop-losses. This is particularly important for an ultra-volatile asset class such as cryptocurrencies.
How to calculate ATR
To build an indicator, you need to find this range. It is done quite simply, by finding the largest of the three numbers:
- the difference between the minimum and maximum on the chart at a given timeframe (daily, weekly, monthly and so on);
- differences between the maximum of the current session and the close of the previous session;
- the difference between the minimum of the current session and the close of the previous session
.
To make it clearer, let’s explain it with an example. Let’s use the daily bitcoin chart:
Source: tradingview.com
Let’s calculate the true range for July 18, 2023. Here’s what we get item by item:
- the difference between the low ($29 521) and the high ($30 244) of the July 18 trading session is $723;
- the difference between the high of the July 18 session ($30 244) and the previous day’s close ($30 154) is $90;
- the difference between the July 18 session low ($29 521) and the July 17 close ($30 154) = $633.
Of the three values ($723, $90, and $633) obtained, the largest is the first one. Hence, it will be the true range. Further, to obtain the average value, the indicator for each specific day (hour, week, month) is calculated, after which the arithmetic mean is calculated. In practice, of course, no one will do this manually in practice. The ATR indicator is quite popular and is present on most trading platforms.
The indicator calculation scheme described above is classical. It was the one that ATR creator Wells Wilder Jr. proposed in the late 70s. In 2023, many traders consider the true range not as the highest of three numbers, but simply as the difference between the high and low of the day. In general, the option also has a right to exist. This is especially true for cryptocurrencies on large timeframes (daily, weekly and monthly), as there are almost no gaps (visual breaks in the chart) formed there. Wilder, on the other hand, researched mainly commodity markets, so he tried to take this factor into account. Gaps were common enough there. Therefore, the classical ATR calculation scheme was appropriate.
And how is the indicator applied, and what is it visually?
How to apply ATR
There are two main directions of ATR application. The first is to determine if a trend is present. The direction up or down is not shown by the ATR. It’s simple: the bigger the ATR, the bigger the price change, and since this is the case, the stronger the volatility, which indicates a trend.
For example, bitcoin had an uptrend from June 15 to June 23: the coin went from $24 756 to $31 458. ATR was going up at the same time. Beginning June 24, the indicator began to fall as BTC began trading in a sideways market where volatility is much lower.
The figure shows the 14-day ATR of bitcoin, the orange arrows show the rise of BTC and the indicator, and the purple arrows show the sidewall and the fall of the indicator:
Source: tradingview.com
But there’s no exact advice to be given here. The only thing is, after ATR started falling, you could sell bitcoin. Again, making one decision or another depends on how you trade or invest.
What seems more interesting is the use of ATR to place stop orders that limit risk. The indicator on average shows how the price has changed over a period of time. Thus, it can be assumed that it is unlikely to change more than the average value. Some use a 2ATR or 4 ATR ratio to avoid unnecessary trade closures;
For example, right now the 14-day ATR is $790. Bitcoin price on Bitstamp exchange on July 19 – $29 920. Thus, you can try to buy BTC at the market price, $29 920, placing a stop at $29 130 (= $29 920 – $790). If you are willing to take a risk, you can place a stop loss at $27 550 (current price – 2 ATR) or at $26 760 (current price – 4ATR).
There is another scheme for applying ATR for those who trade intraday. For example, on July 19, the closing price would be $30 000. And on July 20, the price will soar $3 500, to $33 500 in the first hours of trading. Your ATR is $790, which is 4.4 times less.. What is the most likely pattern of further developments? Decline. Thus, you can open a short position. ATR works similarly in the opposite direction.
Most often platforms have a 14-day ATR in place. You can change the parameters as you need them. There are many cryptocurrencies, volatility is different, so you will need to pick your own parameters for each one.
For all its advantages, ATR has a rather limited application. So when should it not be used?
Disadvantages of ATR
ATR is not a bad indicator that reflects the change in price. However, it would be quite reckless to trade relying solely on it. ATR only shows whether the volatility of a particular cryptocurrency is getting stronger or weaker. But the indicator reflects neither the direction of movement nor the strength of the trend. Therefore, it should be used together with other indicators of technical and fundamental analysis.
The extent to which the ATR is useful will also depend on the goals you have set for yourself and how you are trading. Investors are unlikely to find the indicator very useful. But traders and scalpers can incorporate it into their trading strategies.
In short, ATR is an indicator that shows the volatility of a particular cryptocurrency. It reflects the price trend, but does not indicate the direction of movement. You can’t trade using ATR alone: you need to use it in combination with other indicators.
This material and the information in it do not constitute individual or other investment advice. The opinion of the editorial staff may not coincide with the opinions of the author, analytical portals and experts.