AVERAGE TRUE RANGE
Average True Range or ATR is a measurement of volatility. It measures the average of true price ranges over time. The true range is the greatest distance between today’s high to today’s low, yesterday’s close to today’s high, or yesterday’s close to today’s low. The ATR is a moving average of the true ranges. High ATR values often occur at market bottoms following a panic sell-off. Low ATR values are often found during extended sideways movements, like those found at market tops or after consolidation periods. The ATR can be used in a channel breakout method of trading by adding or subtracting from the previous bar’s close or the current bar’s open.
Now for those of us who do not have the engineer mind, the ATR tells me what the average daily travel distance (up or down) is for a stock or index for a select number of days, which for me is currently based on a 15 day parameter. As an example: if the chart is giving me a number of $1.75 for XYZ stock, then it’s telling me that the stock moved an average of $1.75 per day over the past 15 days. So now you’re asking, how will this be helpful to us? Well, we’re going to use the ATR to help determine our stop loss orders. For those of you that don’t know where to place a stop loss or set your stop loss too closely to the current price of the stock, you’ll now be able to refine where the actual stop loss should be.
Let me begin by explaining a stop loss order for those who are not familiar with stop losses. A stop loss order is simply a price an investor chooses to sell their investment. It is said that one of the most common mistakes investors make is that they don’t know when to sell.We’re going to help you fine tune that skill and help you avoid the most commonly known term: kicked out.
Many investors don’t use a stop loss because once they have chosen a price to sell, it seems that, at times, the price of the stock will drop to your stop loss point, execute the sale of the stock (get kicked out), and then increase in value. This will leave an investor saying, “I wish I didn’t place a stop loss” because the stock moved lower, sold, and is higher now Trust me—this won’t happen every time, and it’s ok! I would rather see an investor use a stop loss then not; and, if your stop loss did get executed and you sold the investment but still like the trade, then enter the trade again. The real purpose of a stop loss order is to protect your profits and limit your losses. Let me show you an example of a prophet.net chart using an ATR. Then, we’ll go a step further with some rules for using the ATR.
The Parabolic SAR is calculated almost independently for each trend in the price. When the price is in an uptrend,the SAR appears below the price and converges upwards towards it. Similarly, on a downtrend, the SAR appears above the price and converges downwards. At each step within a trend, the SAR is calculated ahead of time. That is, tomorrow's SAR value is built using data available today. The general formula used for this is: