What Is the Average True Range (ATR)?
The Average True Range (ATR) is a volatility indicator that was created by J. Welles Wilder. Wilder created ATR with commodities and daily prices in mind, as he did with the most of his indicators. Compared to equities, commodities are sometimes more volatile. They frequently experience gaps and limit moves, which happen when a commodity opens up or closes below the session’s maximum permitted change. The volatility of gap or limit moves would not be captured by a volatility model that solely relies on the high-low range.
In order to account for this “missing” volatility, Wilder developed the Average True Range. It is important to remember that ATR doesn’t indicate price direction, just volatility.In his 1978 book, New Concepts in Technical Trading Systems, Wilder discusses ATR. The Directional Movement Concept (ADX), RSI, and Parabolic SAR are also included in this book. Wilder’s indications have endured and are still widely used even though they were created before the computer era.
True Range
Wilder started with a concept called True Range (TR), which is defined as the greatest of the following:
- Method 1. Current High less the current Low
- Method 2. Current High less the previous Close (absolute value)
- Method 3. Current Low less the previous Close (absolute value)
Positive numbers are ensured by using absolute values. After all, it was the distance, not the direction, between two sites that Wilder was concerned in measuring. The high-low range of the current period will be used as the True Range if the high of the current period is higher than the high of the previous period and the low is lower than the low of the previous period. Method 1 would be used to determine the TR on this outdoor day. This is quite simple. When there is a gap or an inside day, methods two and three are employed. When the previous close is higher than the current high, a gap is created, which could indicate a limit move or gap down. The image below shows examples of when methods 2 and 3 are appropriate.
ATR – True Range Image
Example A. A small high/low range formed after a gap up. The TR equals the absolute value of the difference between the current high and the previous close.
Example B. A small high/low range formed after a gap down. The TR equals the absolute value of the difference between the current low and the previous close.
Example C. Even though the current close is within the previous high/low range, the current high/low range is quite small. In fact, it is smaller than the absolute value of the difference between the current high and the previous close, which is used to value the TR.
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