Trading Crash Course | How to Measure and use Average True Range（ATR）When Trading Cryptocurrencies

- The average true range indicator shows the price volatility of securities such as cryptocurrencies.
- It helps traders to set stop losses and profit targets as well as filtering trends.
- The ATR indicator does not show sell or buy signals.

Keywords: Cryptocurrency, average true range, crypto market, stop loss, take profit



Introduction

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The crypto market is different from the stock market in one major way. Cryptocurrencies are more volatile than stocks or commodities. This creates opportunities for traders to make profits in a short time or incur large losses. Therefore, it is important for crypto traders to use trading tools that help them understand the direction and level of price volatility. The average true range is a technical analysis tool that tracks the volatility of stock or cryptocurrency prices.


What is the average true range (ATR)?

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The average true range (ATR) indicator, developed by J. Welles Wilder Jr in 1978, is a technical analysis tool for tracking the price volatility of an asset such as a cryptocurrency. The ATR increases or decreases depending on changes in the price of a cryptocurrency.

A rise in the value of the ATR indicates that the price volatility of a cryptocurrency has increased. On the contrary, a decrease in the value of the ATR shows that there is a fall in the volatility of an asset.

Traders can use the ATR in several ways. For instance, they use it to identify positions to place stop losses or limit orders. It may help traders with hints on when to enter or exit trades.


Understanding price volatility

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Price volatility refers to fluctuations of the price of an asset within a period. High volatility means that the price of an asset is fluctuating rapidly. On the contrary, there is low volatility when the price of an asset does not fluctuate much.

A security market with high price volatility has a higher risk/reward ratio than the one with low volatility. As such, people execute more trades in volatile markets than stable ones.


How to calculate average true range?

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It is important to note that in our modern day era, the ability to calculate ATR is not important because most trading platforms provide you with such tools. What is essential is the ability of traders to interpret and use them when making trading decisions.

The default period for the ATR indicator is 14. However, individual traders can change the periods according to their needs. For example, traders can use between 2 and 10 periods for short time frames such as one hour. However, they can use 20 to 50 periods for longer time frames such as weeks or months.

The first thing to do when calculating the ATR is to get the true range of the period. You will need the previous close, high and low for the period to calculate the true range. There are three methods of calculating the true range. However, we only use the largest figure from these calculations.

The Current Period High minus (-) Current Period Low
The Absolute Value (abs) of the Current Period High minus (-) the Previous Period Close
The Absolute Value (abs) of the Current Period Low minus (-) the Previous Period Close
After finding the value of the true range, we use the following formula to calculate the ATR.
True Range = max [(high – low), abs (high – previous close), abs (low – previous close)

Nevertheless, it is worth noting that we use the absolute value because we should not have negative figures. Another important thing to understand is that the ATR does not indicate the trend of the price movements. In other words, it does not tell if the price will be rising or falling.

For example, if the ATR is $10 it means the price will either fall or rise by a $10 margin. However, you can only tell the direction of the price movement as the period progresses. Basically, the ATR indicator is a line located at the bottom of the trading chart, as indicated below.


As observed from the chart, the ATR fluctuates up and down, indicating the volatility of the period. When the line moves up it shows increasing volatility. However, when it retraces down it indicates waning volatility.


How the indicator works

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The ATR has a high value when there are fast and large price fluctuations. Mind you when volatility is very high, there is a possibility of a price reversal.

Usually, the values of ATR are low during range markets as there are price consolidations. Therefore, low ATR values indicate weak trend movements. Let’s illustrate these points using the following trading chart.

At point A the volatility is very low while it is high at point B.You can also notice small candlesticks during a period of low volatility. When the ATR is at point B, the candlesticks are large. Also, after reaching point B the volatility starts to decrease.


How to use the ATR indicator

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There are many ways of using the ATR when trading cryptocurrencies. For example, a trader can use the ATR to set profit targets. When there is a strong trading market, traders can set profit targets at multiples of the ATR value. For instance, if the ATR is $100 its multiples include $200 or $300. Depending on the risk preference of a trader, he/she can set the take profit level at a point $200 above the entry value.




Filtering trend

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The ATR values can give traders clues on possible changes in trends. To do that, a trader should add a central line, which is the ATR’s moving average line. If the ATR indicator is below the moving average line it shows that volatility of the asset is low and the trend is weak. When the ATR moves above the centre line, the market is likely to have a new trend.


As the chart shows, when the ATR indicator crosses above the moving average line, volatility is increasing.


Using the ATR to set stop losses

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The concept of setting stop losses using ATR is similar to how one sets profit targets. You can set a stop loss using a point which is 1-4 times the value of ATR. For example if the ATR is $10, you can set your stop loss at a value which is$10, $20, $30 or $40 below the entry price if the asset is in an uptrend.



Using ATR to identify fake breakouts

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A trader can use an ATR indicator to spot a fake breakout. Usually, if there is a divergence between the price and the ATR indicator it means the breakout is false. As an example, if there is a breakout below the support level, but the ATR is not rising there is a fake breakout.


Conclusion

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An ATR indicator helps traders to spot the price volatility of specific cryptocurrencies, commodities and stocks. Crypto traders can benefit much from using the ATR indicator because the prices of cryptocurrencies are very volatile.



Author: Mashell C., Gate.io Researcher
This article represents only the views of the researcher and does not constitute any investment suggestions.
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