The true range is the greatest of the following
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Technical Analysis 38 THE TRADER’S JOURNAL October 2009 The true range is the greatest of the following: ■ The difference between the cur- rent high and the current low ■ The difference between the cur- rent high and the previous close in the event of a gap ■ The difference between the current low and the previous close in the event of a gap ATR is calculated by taking an average of the true ranges over a fixed number of pre- vious periods of data. The key is to use a variable that is not too short or too long. I have found that using a number between 9 and 14 works well with a fair number of sample points. I use the daily bar chart to calculate the average true range for the mar- kets that I trade, not an intra-day chart (5, 15, 60 minute, etc). ATR is simply telling us how much a futures contract has moved up or down on average over the defined period we choose. When the ATR is high, the study is telling us that price ranges are larger and more volatility can be expected. When the ATR value is low, the study is indicating that price ranges are smaller and we can expect less volatility. An observation I have seen is that in bear markets we tend to see much higher levels of average true range because of the fear that is in the markets. Bull markets tend to create complacency and fear levels subside causing the volatility to be reduced. While Mr. Cramer is always look- ing for a bull market somewhere, we as traders should be looking for bear markets to take advantage of the added volatility that leads to more opportunities. Chart 1 shows a daily chart of the E-mini S&P with a 10 period ATR study, showing what the average true range chart looks like. A verage True Range is another tool that I have in my toolbox for trading. Having different tools available allows you to make adjustments to your trading strategy as market con- ditions change. There are hundreds of tools and studies that can be applied to a trading strategy. I do not recommend that you used so many that you become paralyzed when it comes time to pull the trigger for entering or exiting a trade. Markets do change and we must adapt when they do. Knowing how and when to use a particular tool can help increase your edge over the general trading public. Most trading platforms have the Average True Range study built in so we do not have to cal- culate it by hand, reducing the chance for errors. Let’s discuss Average True Range (ATR) and how the study is calculated. The ATR is the average of the true range for a given period. Having different tools available gives the flexibility to make adjustments to your trading strategy as market conditions change. Don Dawson introduces average true range and discusses how it is used in making trading decisions. Chart 1 Now, we have the ATR value. How do we use it to project daily highs and lows? I will illustrate in the next chart how I use ATR during the trading day. You can use this study with the ‘day session only’ prices or the 24-hour Globex prices. I use Globex prices in my analysis. 1. As the regular trading session begins at 9:30 am EST, identify the Globex high and low up to the open. 2. At that point, take the high of the Globex session and subtract the ATR. On this day, the ATR for the previous 10 days was 16.50 points. The Globex high was 1034.25 minus the ATR of 16.50 equals 1017.75. This yields a projected low of today’s anticipated range. We do the same to find the projected high. The Globex low was 1024.25 plus the ATR of 16.50 points equals 1040.75. (See Chart 2 below) October 2009 39 THE TRADER’S JOURNAL
Transcript of The true range is the greatest of the following
Technical Analysis
38 THE TRADER’S JOURNAL October 2009
The true range is thegreatest of the following:
■ The difference between the cur-rent high and the current low
■ The difference between the cur-rent high and the previous close inthe event of a gap
■ The difference between the current lowand the previous close in the event of a gap
ATR is calculated by taking an average ofthe true ranges over a fixed number of pre-vious periods of data. The key is to use avariable that is not too short or too long. Ihave found that using a number between 9and 14 works well with a fair number ofsample points. I use the daily bar chart tocalculate the average true range for the mar-kets that I trade, not an intra-day chart (5,15, 60 minute, etc).
ATR is simply telling us how much afutures contract has moved up or down onaverage over the defined period we choose.When the ATR is high, the study is tellingus that price ranges are larger and morevolatility can be expected. When the ATRvalue is low, the study is indicating thatprice ranges are smaller and we can expectless volatility. An observation I have seen isthat in bear markets we tend to see muchhigher levels of average true range becauseof the fear that is in the markets. Bullmarkets tend to create complacencyand fear levels subside causing thevolatility to be reduced.
While Mr. Cramer is always look-ing for a bull market somewhere, weas traders should be looking for bearmarkets to take advantage of theadded volatility that leads to moreopportunities. Chart 1 shows a dailychart of the E-mini S&P with a 10period ATR study, showing what theaverage true range chart looks like.
Average True Range is another toolthat I have in my toolbox for trading.Having different tools availableallows you to make adjustments toyour trading strategy as market con-
ditions change. There are hundreds of toolsand studies that can be applied to a tradingstrategy.
I do not recommend that you used somany that you become paralyzed when itcomes time to pull the trigger for enteringor exiting a trade. Markets do change andwe must adapt when they do. Knowing
how and when to use a particular toolcan help increase your edge over thegeneral trading public. Most tradingplatforms have the Average True Rangestudy built in so we do not have to cal-culate it by hand, reducing the chancefor errors.
Let’s discuss Average True Range(ATR) and how the study is calculated.The ATR is the average of the truerange for a given period.
Having different tools available gives the flexibility to make adjustments to yourtrading strategy as market conditions change. Don Dawson introduces averagetrue range and discusses how it is used in making trading decisions.
Chart 1
Now, we have the ATR value. How do weuse it to project daily highs and lows?
I will illustrate in the next chart how Iuse ATR during the trading day. You canuse this study with the ‘day session only’prices or the 24-hour Globex prices. I useGlobex prices in my analysis.
1. As the regular trading session begins at9:30 am EST, identify the Globex high andlow up to the open.
2. At that point, take the high of theGlobex session and subtract the ATR. Onthis day, the ATR for the previous 10 dayswas 16.50 points. The Globex high was1034.25 minus the ATR of 16.50 equals1017.75. This yields a projected low oftoday’s anticipated range. We do the sameto find the projected high. The Globex lowwas 1024.25 plus the ATR of 16.50 pointsequals 1040.75.
(See Chart 2 below)
October 2009 39THE TRADER’S JOURNAL
40 THE TRADER’S JOURNAL October 2009
3. On this day, the market made a mini-mal new low under the Globex low and ral-lied. Once this rally started, the projectedhigh for the day should be recalculated.Remember, we are trying to identify theanticipated high to low range for the day, soyou must use the current high and low forthis calculation. You add the ATR of 16.50points to this new low to come up with thenew projected high. In this case, the lowwas 1023 plus the ATR of 16.50 pointsyields a new projected high of 1039.50. Inthis case, we rallied right to this level. (SeeChart 3 above)
Keep in mind that we do not use onetool to make decisions in our trading. Wemust use these tools in conjunction withother technical analysis tools. For example,would I take a short position in this marketjust because it reached my projected high ofthe day? Of course not! Here are some ideasof how I would use this tool to decide on atrade: I would look to the left on my chartfor a support/resistance level that was inconfluence with this projected high or low.This would help validate that level since themarket has traveled its average daily rangeand is sitting at a support/resistance level
∑If the market was at a floor traders’ pivot
level at the same time the market was at aprojected high/low, it would be a good rea-son to take a trade. If I were swing tradingand the market had a countertrend move ofthe direction I wanted to enter a trade, Iwould also consider this as an overbought /
oversold level toenter my swingtrade.
Since most ofmy trading isintraday swingtrading, I find thistool very helpfulwhen I get a signallate in the day.
First, I look tosee how big therange is for the
day. Then, I look to see if there isenough reward left in the move com-pared to my risk. For example, if I geta buy signal risking two points withthe projected high only one pointaway, I will pass on the trade. This par-ticular trade would have an upside-down risk / reward in my opinion risk-ing two points to make a possible one.I really like this ATR study because itkeeps me from buying into resistanceand selling into support.
As with any tool or strategy, this isnot the Holy Grail. If you think aboutthe logic behind this study that themarket has moved X points on averageover the last several days, it is safe toassume that unless some shockingmarket news comes along, this rangewill remain relatively consistent. Ondays when the market has a largeimpulse wave through our projectedhigh or low, you can use this level toenter the market on a pullback –remember old support/resistancereverses roles. At a minimum, you canexpect the market to return to therecent previous swing high or low for atarget after you enter on this pullback.
I recently found this quote that Ihope will remind you that you cannotwin if you do not play.
"I can accept failure, but I can't acceptnot trying" - Michael Jordan TTJ
Adrian Ash runs theresearch desk atBullionVault, theworld's No.1private investorgold service online.Formerly head ofeditorial at FleetStreet Publications– London's toppublisher offinancial advice forprivate investors –he was Citycorrespondent forThe DailyReckoning from2003 to 2008, and isnow a regularcontributor to321gold,FinancialSense,GoldSeek, PrudentBear, SafeHavenand Whiskey &Gunpowder amongmany other leadinginvestmentwebsites. Adrian’sviews on the goldmarket have beensought by leadingnews organizationsincluding theFinancial Times,The Economist,Bloomberg and DerStern in Germany.
