Lessons from the Pros

Stocks

# Average True Range – Your Fuel Gauge for Trading

As traders, we all want to find the highest probable turning points in the markets. At Online Trading Academy, our students learn how to find them through the discovery of high quality supply and demand zones. In addition to the zones, there are several Odds Enhancers that we teach that traders can use to increase their probability of success in the markets.

One odds enhancer is similar to a fuel gauge, the Average True Range (ATR). A fuel gauge in a car tells you how much gas you still have left. If you know your average miles per gallon for the car, you can figure out how far you can still travel without running out of gas. The ATR can tell you how much price movement you may experience before you run out of momentum.

The range of a stock’s price is the difference between the high price and the low price during a period of time.  The true range is a little different in that it also includes any gapping that may have occurred from the prior period.  So, the Average True Range measures the stock’s price vibration, (average movement between high and low) over a period of time.  The default is usually 14 periods.

The ATR of a stock will differ based on the period you have your chart set for.  If you are viewing a daily chart, the ATR will refer to the average movement that stock will make between the high and the low for the day.  If you have your charts set for 15 minutes, then you will see the average movement for every 15-minute period.  When viewing the ATR on a five-minute chart, you are seeing the average price movement for every five-minute candle.

When price is trending strongly in a particular direction, knowing the ATR for that timeframe can offer you a clue as to when price may pause or reverse.  For instance, in the following chart, Apple had a daily ATR of \$1.35.  On April 20th, price opened at \$141.21 and ran upward.  Once price reached the ATR it stalled and drifted sideways.  Eventually, the stock closed one penny off of the projected ATR.

Additionally, when price reaches a supply or demand zone beyond the ATR, it is more likely to reverse.  Though price may still have plenty of momentum when it reaches a supply or demand within the ATR.

We can even use this ATR on a larger timeframe.  For example, look at February’s ATR on XLE of \$6.02.  At the beginning of March, XLE opened and moved upwards before dropping most of the month.  Subtracting the ATR from the high price of the month, we arrived at a target of \$67.11 for the monthly trend.  Just before “running out of gas,” prices reversed.

So, while it is not a perfect timing tool for the markets, the ATR can be used to enhance our trading.  It is an odds enhancer for traders.  To learn more about the other odds enhancers, join us in one of our trading classes at Online Trading Academy today!

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