Average True Range (ATR)
Developed by Wilder, ATR gives Forex traders a feel of what the historical volatility was in order to prepare for trading in the actual market.
Forex currency pairs that get lower ATR readings suggest lower market volatility, while currency pairs with higher ATR indicator readings require appropriate trading adjustments according to higher volatility.
How to read ATR indicator
During more volatile markets ATR moves up, during less volatile market ATR moves down.
ATR indicator doesn't show a trend or a trend duration.
How to trade with Average True Range (ATR)
ATR standard settings - 14. Wilder used daily charts and 14-day ATR to explain the concept of Average Trading Range.
The ATR (Average True Range) indicator helps to determine the average size of the daily trading range.
In other words, it tells how volatile is the market and how much does it move from one point to another during the trading day.
ATR is not a leading indicator, means it does not send signals about market direction or duration, but it gauges one of the most important market parameter - price volatility. Forex Traders use Average True Range indicator to determine the best position for
their trading Stop orders - such stops that with a help of ATR would correspond to the most actual market volatility.
When the market is volatile, traders look for wider stops in order to avoid being stopped out of the trading by some random market noise. When the volatility is low, there is no reason to set wide stops; traders then focus on tighter stops in order to have better protections for their trading positions and accumulated profits.
Let's take an example:
EUR/USD and GBP/JPY pair. Question is: would you put the same distance Stop for both pairs? Probably not. It wouldn't be the best choice if you opt to risk 2% of the account in both cases. Why? EUR/USD moves on average 120 pips a day while GBP/JPY makes 250-300 pips daily. Equal distance stops for both pairs just won't make sense.
How to set stops with Average True Range (ATR) indicator
Look at ATR values and set stops from 2 to 4 time ATR value. Let's look at the screen shot below. For example, if we enter Short trade on the last candle and choose to use 2 ATR stop, then we will take a current ATR value, which is 100, and multiply it by 2.
100 x 2 = 200 pips (A current Stop of 2 ATR)