True range provides a more accurate reflection of the size of a price move over a given period than the standard range calculation, which is simply the high of a price bar minus the low of a price bar.
True range (TR) is a measure of price movement that accounts for the gaps that occur between price bars. The true range calculation was developed by Welles Wilder and discussed in his book New Concepts in Technical Trading Systems (Trend Research, 1978).
Calculation
True range can be calculated on any time frame or price bar — five-minute, hourly, daily, weekly, etc. The following discussion uses daily price bars for simplicity.
True range is the greatest (absolute) distance of the following:
1. Today’s high and today’s low.
2. Today’s high and yesterday’s close.
3. Today’s low and yesterday’s close.
Average true range (ATR) is simply a moving average of the true range over a certain time period. For example, the five-day ATR would be the average of the true range calculations over the last five days.
Key points
True range is a simple volatility calculation — it reflects the degree of price movement over a given period by measuring the total price change from one price bar to the next. The higher the TR or ATR value, the greater the price movement.
Figure 1 shows how standard range and true range compare over a six-day period. Notice that the standard (high minus low) range of each of the first three price bars is five points and, accordingly, the average range for these three days is five points, suggesting the price volatility over this period is neither increasing nor decreasing.
However, the true range calculation for the second day is 8 points, because it factors in the gap between the first and second bars, calculating the range as the distance between the close of bar 1 and the high of bar 2. Similar discrepancies occur between the standard range and true range calculations for the subsequent days. This relationship is further reflected in the average standard range and average true range figures for days four through seven.
The difference is obvious: The standard range calculation only tells you about the price movement for each individual bar. The true range numbers accurately reflect the price movement you would have experienced had you been in this market from one day to the next.
Figure 2 shows a daily bar chart with the 30-day ATR plotted below the price. As the market continued to trade sideways through an extended trading range, the ATR steadily dropped, reflecting the declining volatility. When the currency pair embarked on an uptrend, the ATR moved back up.
Figure 3 is a weekly chart with 12-week ATR. Notice the dramatic increase in ATR/volatility in the GBP/USD that began at the beginning of 2004 — on the heels of a very smooth uptrend from September to December 2003, during which the ATR actually declined.
Interpretation and uses
By increasing or decreasing the number of days in the average, you can use the ATR to monitor volatility on longer- or shorter-term time frames. For example, a five-day ATR would reflect the recent, short-term volatility, while a 50-day ATR would reflect intermediate- to longer-term volatility.
Because it represents the level of price movement in a market, true range can alert you to the trend of volatility (whether it is increasing or decreasing) as well as to when markets are at volatility extremes and might be likely to make significant moves or enter stagnant periods.
Comparing shorter-term ATR to longer-term ATR is one way to do this.
For example, a 100-bar ATR provides an indication of a market’s longer-term volatility; a 10-bar ATR gives an indication of the short-term volatility.
When the short-term ATR becomes very low or high relative to the longerterm ATR, it can suggest a volatility extreme.
For instance, you could test if any noticeable price patterns occur when the short-term ATR falls below a certain percentage (say, 50 percent) of the longer-term ATR. This is simply a way of quantifying the market conditions that exist when a market enters a very narrow consolidation and the resulting breakouts that can result.
Figure 4 shows a 15-minute chart with a line below it that represents the five-bar ATR divided by the 100-bar ATR. Notice the two lowest ATR ratio values corresponded with very tight consolidations, both of which were followed by strong price moves.
Naturally, these examples were chosen to demonstrate a point, but the relationships they represent can be quantified, researched and tested.
True range also can be used to estimate the placement of stop orders or exits. For example, if the five-day ATR is 10 points and your typical trade lasts five days, a stop-loss order that is only
one point away runs a high risk of being hit since it falls well within the natural level of fluctuation the market has recently exhibited.
Similarly, in a strongly trending market, you might set a larger profit target — say, two or three times the ATR — to take advantage of the directional market conditions.
However, in a market that is not trending, a smaller profit target — say, 1 to 1.5 times the ATR — might be more appropriate, given that the market is not indicating it will follow through in any particular direction.
Bottom line
True range more accurately reflects price movement than the standard range calculation because it includes gaps that may occur between price bars. True range and average true range are volatility calculations that can be used in a variety of trading situations — to measure the level of volatility in a market and determine where to place stops and price targets.
The shorter the ATR calculation, the shorter-term the volatility it reflects; the longer the calculation, the longerterm the volatility it tracks.
BY CURRENCY TRADER STAFF
CURRENCY TRADER • February 2005
True range (TR) is a measure of price movement that accounts for the gaps that occur between price bars. The true range calculation was developed by Welles Wilder and discussed in his book New Concepts in Technical Trading Systems (Trend Research, 1978).
Calculation
True range can be calculated on any time frame or price bar — five-minute, hourly, daily, weekly, etc. The following discussion uses daily price bars for simplicity.
True range is the greatest (absolute) distance of the following:
1. Today’s high and today’s low.
2. Today’s high and yesterday’s close.
3. Today’s low and yesterday’s close.
Average true range (ATR) is simply a moving average of the true range over a certain time period. For example, the five-day ATR would be the average of the true range calculations over the last five days.
Key points
True range is a simple volatility calculation — it reflects the degree of price movement over a given period by measuring the total price change from one price bar to the next. The higher the TR or ATR value, the greater the price movement.
Figure 1 shows how standard range and true range compare over a six-day period. Notice that the standard (high minus low) range of each of the first three price bars is five points and, accordingly, the average range for these three days is five points, suggesting the price volatility over this period is neither increasing nor decreasing.
However, the true range calculation for the second day is 8 points, because it factors in the gap between the first and second bars, calculating the range as the distance between the close of bar 1 and the high of bar 2. Similar discrepancies occur between the standard range and true range calculations for the subsequent days. This relationship is further reflected in the average standard range and average true range figures for days four through seven.
The difference is obvious: The standard range calculation only tells you about the price movement for each individual bar. The true range numbers accurately reflect the price movement you would have experienced had you been in this market from one day to the next.
Figure 2 shows a daily bar chart with the 30-day ATR plotted below the price. As the market continued to trade sideways through an extended trading range, the ATR steadily dropped, reflecting the declining volatility. When the currency pair embarked on an uptrend, the ATR moved back up.
Figure 3 is a weekly chart with 12-week ATR. Notice the dramatic increase in ATR/volatility in the GBP/USD that began at the beginning of 2004 — on the heels of a very smooth uptrend from September to December 2003, during which the ATR actually declined.
Interpretation and uses
By increasing or decreasing the number of days in the average, you can use the ATR to monitor volatility on longer- or shorter-term time frames. For example, a five-day ATR would reflect the recent, short-term volatility, while a 50-day ATR would reflect intermediate- to longer-term volatility.
Because it represents the level of price movement in a market, true range can alert you to the trend of volatility (whether it is increasing or decreasing) as well as to when markets are at volatility extremes and might be likely to make significant moves or enter stagnant periods.
Comparing shorter-term ATR to longer-term ATR is one way to do this.
For example, a 100-bar ATR provides an indication of a market’s longer-term volatility; a 10-bar ATR gives an indication of the short-term volatility.
When the short-term ATR becomes very low or high relative to the longerterm ATR, it can suggest a volatility extreme.
For instance, you could test if any noticeable price patterns occur when the short-term ATR falls below a certain percentage (say, 50 percent) of the longer-term ATR. This is simply a way of quantifying the market conditions that exist when a market enters a very narrow consolidation and the resulting breakouts that can result.
Figure 4 shows a 15-minute chart with a line below it that represents the five-bar ATR divided by the 100-bar ATR. Notice the two lowest ATR ratio values corresponded with very tight consolidations, both of which were followed by strong price moves.
Naturally, these examples were chosen to demonstrate a point, but the relationships they represent can be quantified, researched and tested.
True range also can be used to estimate the placement of stop orders or exits. For example, if the five-day ATR is 10 points and your typical trade lasts five days, a stop-loss order that is only
one point away runs a high risk of being hit since it falls well within the natural level of fluctuation the market has recently exhibited.
Similarly, in a strongly trending market, you might set a larger profit target — say, two or three times the ATR — to take advantage of the directional market conditions.
However, in a market that is not trending, a smaller profit target — say, 1 to 1.5 times the ATR — might be more appropriate, given that the market is not indicating it will follow through in any particular direction.
Bottom line
True range more accurately reflects price movement than the standard range calculation because it includes gaps that may occur between price bars. True range and average true range are volatility calculations that can be used in a variety of trading situations — to measure the level of volatility in a market and determine where to place stops and price targets.
The shorter the ATR calculation, the shorter-term the volatility it reflects; the longer the calculation, the longerterm the volatility it tracks.
BY CURRENCY TRADER STAFF
CURRENCY TRADER • February 2005
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