Average True Range (ATR)
Before explaining about ATR, we have to discuss a bit on Volatility as the whole concept of ATR depends on market volatility.
What is volatility?
Technically, if the difference of High and low is large, the volatility is more which means that the market movement is large IRRESPECITVE OF DIRECTION in the given period of time. So, whether it’s a bull, bear market, if the range of the current period in respect with the previous period is large, it is said to have a good volatility (Shown in the chart below). To say in general, if the zigzag movement is more, volatility is more and if the whipsaws are less, that seems to be a less volatile market.
It’s pretty clear in the above chart that the markets are falling and ATR rising in the first half and in the second half, when markets are recovering from its low, ATR showing weakness in the trend.
ATR is an indicator which uses absolute true ranges for calculating the volatility. It is therefore one of the famous volatility indicators. Though we are not concerned about the calculation part of the ATR as of now, we should know that its impossible to get the ATR value for the first day as ATR calculation takes the previous day’s close into consideration. This is the reason; we can get ATR value only from the second day of the given period.
Certain drawbacks are said to be involved in ATR as they are non-comparable. The reason being, the stock with high price may have high ATR and a stock with low price would have low ATR. Also, it doesn’t show any interest in finding the direction of the moves.