The high to low price differential in a stock, ETF, commodity or currency is an import attribute that often gets overlooked when traders get caught up in the emotion of volatile market movements.
The trading range is critical for short-term trading to provide perspective on how the market movement compares to typical sessions.
Anything can happen on a given day making the Average True Range calculation the better guide to normal market movements. A 20-day average of the most recent trading day’s range smoothes out day-to-day volatility.
The resulting 20-day ATR is insightful when determining potential range boundaries. A statistical measure of how far markets may move is extremely valuable. The Average True Range average is dynamic, changing as the volatility increases or decreases.
Two Uses FOR Average True Range
- Gap Open—Information released when markets are closed can cause a sharp movement in price when trading resumes. The emotion of the pop or plunge needs perspective to see how much further the play has to run based on typical price action.
- Example: The E-mini S&P futures contract had an ATR of 16 with the market opening down 14. That information suggests that prices only have a few points left on the downside to the move the average trading range. Obviously, anything can happen but the risk to reward ratio is not on the bearish side at the open.
- Consolidation Breakout—A sideways market that has not determined daily direction is watched for a bust out of the established highs or lows. The point difference in the trading channel is added or subtracted from the breakout to determine the measured move objective. If the ATR has not been achieved, the confidence in the breakout is increased.
- Example: At noon the E-mini S&P with a 16 point ATR has been an 8 point track. A breakout targets another 8 point extension which is a reasonable goal within the calculated ATR.
Average True Range is used for perspective—markets can always move more or less than you might think—as a statistical norm in the not normal world of trading.
