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Introduction

DevelopedbyJ . Welles Wilder, the Average TrueRange (ATR) is an indicator thatmeasuresvolatility. As

with most of his indicators, Wilder designed ATR with commodities anddailyprices in mind. Commodities

arefrequentlymore volatile than stocks. Theywereareoftensubject togaps and limit moves, whichoccur

whena commodity opens up or downits maximumallowedmove for the session. A volatility formulabased

only on the high-lowrange wouldfail tocapture volatility from gap or limit moves. Wilder createdAverage

True Range to capture this "missing" volatility. It is important to remember thatATR does notprovide an

indication of price direction, just volatility.

Wilder features ATR in his 1978 book, New Concepts in Technical Trading Systems. This bookalso

includes the Parabolic SAR, RSI and the Directional Movement Concept (ADX). Despite beingdeveloped

before the computer age, Wilder's indicators havestoodthe test of time andremain extremelypopular.

True Range

Wilder started witha concept calledTrue Range (TR), which is defined as the greatest of the following:

Method 1: CurrentHigh less the current Low

Method 2: Current High less the previous Close (absolutevalue)

Method 3: CurrentLow less the previous Close (absolute value)

Absolutevalues are usedtoensure positivenumbers. After all, Wilder was interested in measuring the distance between two points, not the direction. If the

current period's high is above the prior period's high and the lowis belowthe prior period's low, then the current period's high-lowrange will be usedas the Tru

Range. This is anoutside day that woulduse Method 1 to calculate the TR. This is pretty straight forward. Methods 2and 3 are used whenthere is a gap oran

inside day. A gapoccurs whenthe previous close is greater than the currenthigh (signaling a potential gap downor limit move)or the previous close is lower t

the current low(signaling a potential gap upor limit move). The image belowshows examples of whenmethods 2 and 3 are appropriate.

ExampleA: A small high/lowrange formed after a gap up. The TR equals the absolutevalue of the difference between the current high and the previous close

ExampleB: A small high/lowrange formed after a gap down. The TR equals the absolutevalue of the difference between the current lowand the previous clos

ExampleC: Even though the current close is within the previous high/low range, the current high/lowrange is quite small. In fact, it is smaller than the absolute

value of the difference between the currenthigh and the previous close, which is used tovalue the TR.

Calculation

Typically, the Average True Range (ATR) is based on14periods and can becalculated onanintraday, daily, weekly ormonthlybasis. For this example, the AT

will bebased on dailydata. Because there mustbe a beginning, the first TR value is simplythe High minus the Low, andthe first 14-dayATR is the average o

the dailyTR values for the last14days. After that, Wilder sought tosmooth the databyincorporating the previous period's ATR value.

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Curr ent ATR = [ ( Pri or ATR x 13) + Curr ent TR] / 14

- Mul t i pl y t he previ ous 14- day ATR by 13.

- Add t he most r ecent day' s TR val ue.

- Di vi de t he t otal by 14

Clickhere for anExcel Spreadsheetshowingthe startof an ATR calculation forQQQ.

In the spreadsheet example, the first True Range value (.91) equals the High minus the Low(yellowcells). Thefirst 14-day ATR value (.56)) was calculated by

findingthe average of the first 14True Range values (blue cell). Subsequent ATR values weresmoothed using the formula above. The spreadsheet values

correspondwith the yellowarea on the chart below. Notice how ATR surged as QQQQ plunged in Maywith many long candlesticks.















For those tryingthis athome, a fewcaveats apply. First, ATR values depend on where you begin. The first True Range value is simplythe currentHigh minus currentLowand the first ATR is an average of the first 14TrueRange values. The real ATR formula does not kick in until day15. Even so, the remnants of th

first two calculations linger toslightly affect ATR values. Spreadsheetvalues for a small subset of datamaynot match exactly withwhat is seen on the price ch

Decimal roundingcan also slightly affect ATR values.

Abso lut e ATR

ATR is based on the True Range, which uses absoluteprice changes. As such, ATR reflects volatility as absolute level. Inother words, ATR is not shown as

percentage of the current close. This means lowpricedstocks will have lower ATR values than high price stocks. Forexample, a $20-30securitywill have muc

lower ATR values than a $200-300 security. Because of this, ATR values are not comparable. Even large price movements for a single security, such as adec

from 70to20, can make long-term ATR comparisons impractical. Chart 4 shows Google withdouble digit ATR values andchart 5 shows Microsoft with ATR

values below 1. Despite different values, theirATR lines have similar shapes.















Conclusions

ATR is nota directional indicator, such as MACD or RSI. Instead, ATR is a unique volatility indicator that reflects the degree of interest or disinterest in a move

Strong moves, in either direction, are oftenaccompanied bylarge ranges, or large True Ranges. This is especially true atthe beginning of a move. Uninspiring

moves can be accompanied byrelativelynarrow ranges. As such, ATR can be used tovalidate the enthusiasm behind a move or breakout. A bullish reversal w

an increase in ATR would show strong buying pressureand reinforce the reversal. A bearish supportbreak with an increase in ATR would show strong selling

pressureand reinforce the support break.

SharpCharts

Listed as "Average True Range", ATR is on the Indicators drop-downmenu. The "parameters" box tothe rightof the indicator contains the defaultvalue, 14, fo

the number of periods used tosmooth the data. To adjustthe period setting, highlight the defaultvalue and enter anew setting. Wilder oftenused 8 period AT

SharpCharts alsoallows users to position the indicator above, below, or behind the price plot. A moving average can beadded toidentifyupturns or downturns

ATR. Click "advanced options" toadd a movingaverage as an indicatoroverlay. Clickherefor a live example of ATR.

Further Study

New Concepts in Technical Trading Systems

Welles Wilder














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Stocks & Commodities Magazine Articles:

Working Money: Average True Range by Sharon Yamanaka

Feb 2002 - Stocks & Commodities

Which Volatility Measure? by Gordon Gustafson

May 2001 - Stocks &Commodities V. 19:6 (46-50)

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