ATR: how much price moves

How far does price usually move?

Some stocks move a few cents a day. Others swing by dollars. Before you plan a trade, it helps to know what a normal move looks like. That's what ATR measures. ATR stands for Average True Range. It was created by J. Welles Wilder in 1978, the same person who made RSI.

Step 1: the range

The range of a candle is its high minus its low. If a stock traded between $10 and $12 today, the range is $2.

Step 2: the true range

Sometimes price jumps overnight. Yesterday it closed at $10. Today it opens at $13 and trades between $12 and $14. Today's candle only covers $2 (14 - 12). But price really traveled from $10 all the way up to $14. That's $4 of movement!

So the true range picks the biggest of three distances:

1. Today's high to today's low.
2. Today's high to yesterday's close. This one wins when price gaps up.
3. Today's low to yesterday's close. This one wins when price gaps down.

In our example: high to low is 14 - 12 = 2. High to yesterday's close is 14 - 10 = 4. Low to yesterday's close is 12 - 10 = 2. The biggest is 4, so the true range is $4.

Step 3: the average

ATR is the average of the true ranges. The usual setting is 14 candles.

Tiny example with 3 days: true ranges of $2, $3 and $1. Average: (2 + 3 + 1) ÷ 3 = $2. So a normal day moves about $2. The real ATR uses a smoothed average, so it changes a little more slowly, but the idea is the same.

How traders use it

Planning a stop. A stop loss is an order that gets you out of a trade if price moves against you to a level you picked ahead of time. If a normal day moves $2 and a stop sits only 10 cents away, ordinary wiggles will probably knock it out, even when the trade idea was fine. That's why many traders measure stop distances in ATRs, for example 1.5 or 2 times the ATR.

Sizing a trade. When a stock's ATR is big, each share swings more. Careful traders buy fewer shares of wild stocks, so a wild stock and a calm stock carry about the same risk.

Spotting change. ATR rising means the market is getting wilder. ATR falling means it's calming down.

Where it fails

ATR tells you how much price moves, never which way. A big ATR doesn't mean up and it doesn't mean down. It's also built from the past. On a surprise news day, price can move several times its ATR, and yesterday's "normal" means nothing.

Remember

• Range = high minus low. True range also counts jumps from yesterday's close.
• ATR is the average true range, usually over 14 candles.
• Traders use it to give stops room for normal wiggles and to size trades.
• ATR shows how much price moves, never which direction.