2 Simple Ways to Use Average True Range in Your Trading Strategy

You’ve probably know about using stop losses and trailing stops in your trading, but there’s a smarter way to set them up using Average True Range (ATR). Instead of relying on fixed amounts or gut feelings, ATR helps you adapt to the market’s actual volatility. When you understand how to calculate and implement ATR-based stops, you’ll notice your trades becoming more precise and your risk management more effective. Let’s explore two powerful ATR techniques that can transform your trading approach.

TLDR

• Use ATR to set trailing stops by adding 2x ATR to closing price, allowing profits to run while protecting gains.
• Calculate stop loss placement by multiplying ATR by 2 below entry point to avoid premature exits.
• Apply ATR to measure market volatility and determine appropriate position sizes based on current market conditions.
• Set entry points using ATR to identify optimal trade opportunities when price moves beyond normal volatility ranges.
• Utilize ATR for dynamic risk management by adjusting stop distances according to market momentum and volatility levels.

What Exactly Is The ATR Indicator

The ATR indicator measures an instrument’s price movement. For day traders, understanding how far a price typically moves during an intraday session provides valuable insight. It’s not logical to enter directional trades when an instrument has already moved beyond its average daily range.

Day traders who begin at the start of a trading session can determine their profit expectations by checking the average true range indicator. While markets are unpredictable, having a baseline expectation is valuable, and traders can adjust their strategy if they notice higher volatility developing throughout the day.

The calculation involves two steps with the first one finding the true range of the instrument:

• Current High minus current Low
• Current High less previous Closing price
• Current Low less previous Closing price

For a 14 period ATR setting which is the default, the last calculation is: Current ATR = [(Prior ATR x 13) + Current TR] / 14.

From the final ATR number, we can see if an instrument is becoming more or less active when compared to the recent past – and this includes small time frames such as 5 minute charts up to the large time frames.

Understanding whether an instrument shows a lack of price movement can help you decide if it’s a market worth trading. Some traders consider a low ATR reading as an ideal time to watch for a trading range, and they will then monitor the market for a potential breakout.

Other traders will see a falling ATR reading on an instrument as lower profit potential and lack of momentum due to the lack of market volatility.

Your interpretation of the ATR reading isn’t about right or wrong answers. What matters most is maintaining consistency in your approach, ensuring everything fits within a tested trading plan, and using it alongside a trading strategy that gives you an edge in the market.

2 Important Uses Of Average True Range Indicator

There are several different ways to use the ATR (Average True Range) indicator, even as a standalone trading strategy. I want to focus on two specific techniques that you can begin testing today. You’ll likely see positive results right away when implementing these two methods.

Let Your Profits Run

One of the easiest things for a trader to do is to hit close when they see decent profits on their trade. This is common among undisciplined traders and those that have long losing streaks.

Getting out of a profitable trade too early when market momentum is still strong can be just as detrimental as holding onto losing positions. Our goal is to maximize potential gains from the market until we observe clear signs that conditions are changing.

One use of ATR is as a trailing stop and the logic is that if the market moves adversely against you in line with average range of the market, you may be seeing a shift in the underlying driver of the instrument.

On this chart I have added a 14 period ATR to the bottom and on the price portion, this indicator calculates the price point for the trailing stop. For short trades, the calculation is from the close of the candlestick plus 2 X ATR.

In this example, we have a basic trading strategy of upside trend line break entry n the context of a down trend shifting to an uptrend.

The ATR trailing stop is calculated at every candlestick close which allows you to take advantage of this move until adverse price action takes you out. The plus side to the exit is you are being stopped out when price is in a trading range. You can never be certain a range does not break in the opposite direction of your trade.

Set Stop Loss At Objective Price Points

Setting your stop loss is vital to protecting your capital. While some traders will keep a mental stop, the main point is that knowing where to exit when price is pulling against you is vital.

The key is to find a place on the chart that:

• Takes into account the momentum in the market
• Allows for the ebb and flow of price movement
• Exits your trade, perhaps at a loss, when trading conditions are not optimal

To properly set your stop loss, use a multiple of the Average True Range (ATR). This approach respects market volatility rather than setting a tight stop just to increase your position size.

This is a standard pullback setup after a strong move off the lows. Price pulls back and after a red momentum candle, an inside bar sets up. Trade break of inside bar long and stop goes 2 or 3 times the ATR reading.

Something to consider…..

When considering ATR, we are referring to a range of price where highs and lows are used in the calculation. You will have to determine, using this example, whether you would use the closing price of the candlestick or the high in the case of a buy trade setup.

There will be times where there is not much of a difference in the price.

Is ATR Right For You?

Whether you’re a day trader or a swing trader, having an objective way to measure an instrument’s volatility can significantly impact how you interact with the market.

Trailing your stops is something that many traders do and often times they will use price structures such as support or resistance.

As I wrote about here in regards to failure tests and trapped traders, price can breach these zones without invalidating the trade. You will be taken out of the trade at the exact moment you should be entering.

While letting your profitable trades run until market conditions shift is an effective strategy, it’s not the only way to generate market-beating returns.

Trading without an initial stop loss puts you at risk of disaster. It’s important to know your exit point if the trade doesn’t move in your favor shortly after entering – this is essential for managing risk and protecting your trading account.

Using an ATR stop helps protect you from market noise and random price fluctuations until your trade gains momentum. You don’t need to wait for your stop loss to be triggered if you observe strong opposing price action, as this might simply indicate that you entered the trade too early.

Your Questions Answered

How Does ATR Perform in Different Market Conditions Like High Volatility?

ATR’s performance adapts well to changing market volatility because it’s based on price movement ranges.

When markets are highly volatile, ATR values increase, giving you wider stops that prevent premature exits.

In calmer markets, ATR naturally tightens, offering closer stops.

You’ll find this flexibility especially useful since your stops will automatically adjust to match current market conditions, helping protect your trades effectively.

Can ATR Be Combined With Other Technical Indicators for Better Results?

You’ll find great indicator collaboration when combining ATR with other technical tools.

Try pairing it with moving averages to confirm trend strength, or use it with RSI to validate momentum signals.

The ATR interplay works well with support and resistance levels too – it helps you set more precise entry and exit points.

What’s the Optimal ATR Period Setting for Different Trading Timeframes?

For short-term trading on hourly or daily charts, you’ll want to use ATR settings between 7-14 periods to stay responsive to recent volatility.

If you’re trading longer timeframes like weekly or monthly charts, consider using 14-21 periods for your ATR settings.

How Do You Adjust ATR Calculations for Different Asset Classes?

You’ll need to adjust your ATR calculations based on each asset’s unique characteristics.

For stocks, you might use a standard 14-period ATR, while forex often requires shorter periods due to higher volatility.

With cryptocurrencies, you’ll want to widen your ATR multiplier to account for extreme price swings.

Remember that more volatile assets need larger ATR adjustments to avoid premature stops and better match the asset’s typical price movements.

Is ATR More Effective for Day Trading or Longer-Term Position Trades?

ATR works effectively for both trading styles, but you’ll find it especially useful for short term strategies since it captures recent volatility more accurately.

For day trading, it helps you set tighter stops and quick profit targets based on intraday price movements.

In longer-term position trades, ATR can help you track long term trends and set wider stops to avoid getting shaken out by normal market fluctuations.

Conclusion

You’ve now learned two powerful ways to use ATR in your trading. By setting stop losses based on market volatility and implementing trailing stops, you’ll better protect your capital and capture more profits. These ATR techniques help remove emotion from your trading decisions and adapt to changing market conditions. Start applying these methods today to improve your trading results and consistency.