What is Average True Range ?

Definition

The Average True Range (ATR) is a technical analysis indicator used to measure market volatility by decomposing the entire range of an asset price over a specific period.

Origin

ATR was introduced by market technician J. Welles Wilder Jr. in his book "New Concepts in Technical Trading Systems." The indicator was designed to help traders better understand market volatility.

Categories and Features

ATR determines the true range by calculating the maximum of the following three values: the current high minus the current low; the absolute value of the current high minus the previous close; and the absolute value of the current low minus the previous close. ATR is then the moving average of these true ranges, typically using a 14-day period. Traders can adjust the period length to generate more or fewer trading signals as needed.

Case Studies

During the 2008 financial crisis, the ATR of many stocks increased significantly, reflecting extreme market volatility. For example, Citigroup's stock saw a substantial rise in ATR during the crisis, indicating investor reactions to market uncertainty. Another example is the early 2020 COVID-19 pandemic, where the ATR of the S&P 500 index also rose significantly, showing the market's response to global economic uncertainty.

Common Issues

Investors using ATR may encounter issues such as misunderstanding the strength of ATR signals. ATR is merely a measure of volatility, not an indicator of price direction. Additionally, over-reliance on ATR might lead to neglecting other important market indicators.