ATR - Average True Range
Thursday, December 21, 2006 at 10:18AM
I have received a few e-mails and requests to write about ATR. It is a very simple indicator and very simple to use. I have taken a piece off the toolbox that I wrote and will place it here to give you an idea of how to use. Here you go:
After you have completed all your analysis to place a trade, now the fun begins. “Where do I place my stop order?” Setting a stop order is mandatory if you are interested in limiting your losses, and you must limit your losses to be a successful trader. In determining where to set a stop order, a few questions to ask yourself are, how much are you willing to lose? Where is support? Where is a safe place I can place a stop that will protect me, yet not take me out on a volatile day? I occasionally hear people say that they wish there was a technical indicator that could be used to take out all the guesswork of where to place a stop. Guess what? There already is an indicator that can be used to facilitate this! The indicator is called an Average True Range, or ATR indicator.
J. Welles Wilder introduced this indicator in 1978. The ATR indicator is used to measure a securities volatility, not price direction or duration. It was originally designed for commodities since it takes daily price data into consideration, but can be used for stocks as well. The ATR is most commonly used at a 14 day time period. To see this indicator, go into the Interactive Chart and select it from the “Select Studies” drop down menu. When you add it to your chart it will give you a current reading relative to your stock. Keep in mind that a $20 stock will have a lower ATR reading than let’s say a $100 stock. The idea is to see what the indicator tells you now, and what your extreme high points and low points are.
Hope that helps. Stay tuned...
Is there a Technical Indicator I can use to tell me where I should place my Stop Order?
After you have completed all your analysis to place a trade, now the fun begins. “Where do I place my stop order?” Setting a stop order is mandatory if you are interested in limiting your losses, and you must limit your losses to be a successful trader. In determining where to set a stop order, a few questions to ask yourself are, how much are you willing to lose? Where is support? Where is a safe place I can place a stop that will protect me, yet not take me out on a volatile day? I occasionally hear people say that they wish there was a technical indicator that could be used to take out all the guesswork of where to place a stop. Guess what? There already is an indicator that can be used to facilitate this! The indicator is called an Average True Range, or ATR indicator.J. Welles Wilder introduced this indicator in 1978. The ATR indicator is used to measure a securities volatility, not price direction or duration. It was originally designed for commodities since it takes daily price data into consideration, but can be used for stocks as well. The ATR is most commonly used at a 14 day time period. To see this indicator, go into the Interactive Chart and select it from the “Select Studies” drop down menu. When you add it to your chart it will give you a current reading relative to your stock. Keep in mind that a $20 stock will have a lower ATR reading than let’s say a $100 stock. The idea is to see what the indicator tells you now, and what your extreme high points and low points are.
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Let’s assume your ATR gives you a reading of 2.0, and a high of 3.5. This means that the stock as of now could fluctuate within a $2 price range. Over time if 3.5 is your highest ATR reading, than historically you can see that even at it’s wildest moment, the stock didn’t swing more than $3.50 during heightened points of volatility. So even if I wanted to use an extreme measure, I could set my stop $3.50 below the stock price and this would be a safe enough place to not trigger my order on a volatile day, yet still protect me from a potential breakout to the downside. You will still want to use support and resistance points to tell you if your stock breaks and one of these points, but an ATR indicator is a great way to set a stop order when you are trying to find where even the most volatile points won’t trigger it.
Hope that helps. Stay tuned...
Reader Comments (9)
Dumb question, but is this the average true range for a TRADING DAY? In other words, do you adjust your stop each day based on the ATR?
Example: If the stock is $50 and has an ATR of $1.50, you'd put your stop in at $58.45 or so. But if the stock climbs $1 on the day, do you adjust it to $59.45 the next day. Is that correct?
I know that ATR is measured over a 14-day period, so the logical answer would be that you use this as a 14-day stop. But I'm unclear how often this should be adjusted. Every 14 days? Every day?
This is most commonly used as a trailing stop methodology. Meaning since your ATR was at 1.50, you put a trailing stop based on the value of the stock, 1.50 below current price. The only time you'd need to adjust, is if your ATR has changed by a good enough amount. Does that make sense?
I was following your comments nicely until the last post by Jeff. Jeff, when you say that you shouldn't have to adjust it at all are you talking about the ATR or the stop price? The way I understand it, since it is an average, the ATR will not fluctuate much daily but the stop price is a set amount that would need to be adjusted up as the stock price increases.?
Danny K
Jeff's referring to a trailing stop order which most brokerages will allow you to do. I have just switched brokerages and haven't figured out how to do that yet, but it's pure genius!! You just say "I want to set my stop at the last close price minus "X" and voila... (as we say up here in Canada) you're covered.
Sure wish I'd had that set up on IIG.
Have a great Holiday Season, everyone.
Chris and Catherine.