The Average True Range (ATR), developed by J. Welles Wilder, measures how much a market typically moves over a given period. Unlike most indicators, ATR says nothing about direction — it only measures the size of price swings. This makes it one of the most practical tools for risk management.
How ATR Is Calculated
The True Range for a single period is the largest of three values: the current high minus the current low, the current high minus the previous close, or the current low minus the previous close. Using the previous close accounts for gaps. ATR is then a moving average — typically 14 periods — of the True Range values.
ATR = Average(TrueRange, n periods), where TrueRange = max(High-Low, |High-PrevClose|, |Low-PrevClose|)Reading ATR Values
- ▸A rising ATR means volatility is increasing — moves are getting larger.
- ▸A falling ATR means volatility is contracting — the market is quieting down, often before a breakout.
- ▸ATR values are absolute (in price units), so they must be compared to the instrument's own history, not across different assets.
Using ATR for Stop-Loss Placement
A fixed stop of, say, 20 pips makes no sense across all conditions — in a quiet market it is too wide, in a volatile market it gets hit by normal noise. A volatility-based stop, such as 1.5x or 2x ATR away from entry, adapts automatically to current conditions.
Using ATR for Position Sizing
Combine ATR with a fixed risk percentage: decide how much account equity you are willing to risk, then divide that amount by the ATR-based stop distance to determine position size. This way, risk per trade stays constant even as volatility changes.
Many traders set targets as a multiple of ATR too, such as a 2:1 or 3:1 reward-to-risk ratio measured in ATR units. This keeps stop and target proportional to actual market movement rather than arbitrary pip counts.
ATR and Market Phases
Volatility tends to cluster and cycle: periods of low ATR (consolidation) are often followed by periods of high ATR (breakout and trending), which then contract again. Watching for ATR compressing to multi-week lows can flag that a larger move may be building.
ATR never tells you whether price will go up or down — only how far it might move. It must always be combined with a directional method such as trend structure or a momentum indicator.