CFDs are a leveraged product and can result in losses that exceed deposits. Trading CFDs may not be suitable for everyone, so please ensure you fully understand the risks and take care to manage your exposure.

How to trade average true range

We look at the average true range, and how it can be used in trading and stop placement.

CFDs are a leveraged product and can result in losses that exceed deposits. Trading CFDs may not be suitable for everyone, so please ensure you fully understand the risks and take care to manage your exposure.
Chart
Source: Bloomberg

The average true range (ATR) is an indicator designed to measure the volatility of an asset. It is calculated by taking the moving average, usually 14 days, of the true range. The true range is the largest of the following three:

  • the current high minus the current low
  • the value of the current high minus the previous close
  • the value of the current low minus the previous close

It was originally developed to measure volatility in commodities, but like many indicators it has found use for all markets. It allows traders to measure the daily volatility of an asset, and whether this is increasing or decreasing, and thus used as an aid to position sizing and stop placing. It does not indicate price direction, but instead tracks how much an asset moves in a given time period.

The chart below shows the FTSE 100, with a 14-day ATR. From the middle of the month ATR begins to rise, as the index experiences heightened volatility:

ATR can be utilised for stop placement. A higher ATR reading suggests greater intraday volatility, and thus stops should be wider in order to avoid having a position stopped out on a sudden swing. With wider stops, of course, it follows that position sizes will be smaller, if traders are following (as they should be) the rule that no trade risks more than 2% of your account size.

Thus, taking the example from above, a stop utilising the ATR method placed on a trade in the middle of the month, when the ATR was around 20, will be narrower than on a trade in late January, when ATR is 26.

A common method of using ATR in stop placement involves using multiples of ATR, perhaps twice the current ATR level (known as ‘2ATR’). This means that the possibility of a trade being stopped out by a sudden volatile move is reduced, since it is rare to see the price move by twice the ATR.

This information has been prepared by IG, a trading name of IG Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication.  Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. 

CFDs are a leveraged products. CFD trading may not be suitable for everyone and can result in losses that exceed your initial deposit, so please ensure that you fully understand the risks involved.

Find articles by analysts