Average True Range (ATR)

The ATR indicator is calculated by taking the average of the True Range over a set number of periods, typically 14. For each candlestick, the True Range is the greatest of the following: the difference between the current high and low, the difference between the current high and the previous close, or the difference between the current low and the previous close. This method effectively accounts for price gaps between candles.

Unlike most indicators, the ATR does not provide bullish or bearish directional signals; it solely measures the level of volatility or activity in the market. A rising ATR value indicates high volatility and wide price swings, whereas a falling value reflects relative market quiet.

Traders primarily use the ATR to dynamically set stop-loss and take-profit levels tailored to current market volatility rather than relying on fixed distances. For instance, a stop-loss might be placed at a distance of twice the ATR value from the entry point. It is also utilized to calculate appropriate position sizing in alignment with acceptable risk levels.

A common mistake is confusing the ATR with directional trend indicators; a rising ATR does not necessarily signify an uptrend, as it can just as easily accompany a sharp market decline. Additionally, stop-loss calculations should be reassessed periodically as the ATR value shifts, rather than relying on a static figure throughout the life of the trade.