Average True Range
Average True Range (ATR) is a volatility indicator developed by J. Welles Wilder Jr. that measures the average magnitude of a security's historical price movements over a specified period, incorporating gaps between sessions to capture the full range of price activity.
Average True Range was introduced by J. Welles Wilder Jr. in his 1978 book 'New Concepts in Technical Trading Systems,' alongside the RSI and several other indicators. ATR measures historical price volatility — not direction — by calculating the 'true range' for each period and then smoothing those values into a running average.
The true range for any single period is defined as the greatest of three values: (1) the current period high minus the current period low, (2) the absolute value of the current period high minus the prior period close, and (3) the absolute value of the current period low minus the prior period close. By incorporating the prior period's close into the calculation, true range captures gap openings — situations where the security opens significantly above or below its prior closing price — which a simple high-minus-low calculation would miss. ATR is then calculated as Wilder's smoothed moving average of the true range over the look-back period, typically 14 periods.
ATR does not provide directional information; a high ATR value simply means a security has been historically volatile in absolute price terms. A low ATR value indicates the security has historically moved in smaller absolute ranges. ATR values are expressed in the same units as the security's price, making it easier to interpret in absolute terms compared to percentage-based volatility measures.
Practical applications of ATR are numerous. Technical analysts have historically used ATR to calibrate stop-loss placement: setting a stop-loss at one or two ATR units below the entry price attempts to account for the security's normal historical price volatility, potentially reducing the frequency of being stopped out by routine price fluctuations. ATR is also used to compare volatility across securities and to adjust position sizes in proportion to historical volatility — a form of volatility-normalized position sizing described in various systematic trading frameworks.
Because ATR measures historical volatility, periods of ATR compression — historically low ATR values — have been studied in historical data in relation to subsequent periods of elevated price movement, consistent with the tendency of markets to cycle between periods of high and low volatility. This is an historical observation about volatility cycles; ATR does not forecast the direction of any subsequent price move.