The average true range, or ATR, measures how much a stock, index or contract typically moves in a period. It says nothing about direction. Its value lies in answering a practical question every trader faces: how far might this move on an ordinary day?
This article explains how ATR is calculated, why it handles gaps better than a simple high-low range, and how traders use it to set stop distances and position sizes that fit the instrument's actual volatility.
True range, then the average
ATR was introduced by J. Welles Wilder. It starts with the true range for each period, which is the largest of three values:
1. Today's high minus today's low.
2. The absolute difference between today's high and yesterday's close.
3. The absolute difference between today's low and yesterday's close.
Worked example. Yesterday's close was 100. Today the stock opened with a gap and traded between a low of 101 and a high of 104.
High − low = 3
|High − previous close| = |104 − 100| = 4
|Low − previous close| = |101 − 100| = 1
The true range is the largest: 4. A simple high-low range of 3 would have missed the overnight gap from 100 to 101.
The ATR is then a smoothed average of true ranges, commonly over 14 periods, using Wilder's smoothing method. If the last 14 true ranges average 5, the 14-day ATR is 5: on a typical day, the stock has moved about 5 rupees from its extreme to extreme, gaps included.
What ATR tells you, and what it doesn't
It measures volatility in price units. An ATR of 5 on a ₹100 stock is a 5 percent typical range; on a ₹1,000 stock it is 0.5 percent. To compare instruments, divide ATR by the price to get a percentage.
It changes with conditions. ATR rises in turbulent markets and falls in calm ones. A stop distance that was sensible in a quiet month may be far too tight after volatility jumps.
It has no direction. A rising ATR can accompany a sharp rally or a sharp fall.
It describes the past. ATR tells you how much the instrument has been moving, not how much it will move. Events such as results can produce moves several times the ATR.
Using ATR to set stop distances
A stop placed too close to the entry price gets hit by ordinary noise; one placed too far away risks more than necessary. ATR gives a way to scale the distance to the instrument.
A common approach is to place a stop a multiple of ATR away from the entry, such as 1.5 to 3 times ATR depending on the holding period and strategy.
Example. A stock trades at 500 with a 14-day ATR of 10. A trader buying with a 2 × ATR stop places it at 500 − 20 = 480. A different stock at 500 with an ATR of 4 would get a stop at 492 under the same rule, because it normally moves much less.
Trailing stops. Some traders trail the stop at a fixed multiple of ATR below the highest close since entry, so it follows a rising price while staying outside normal daily swings. The Supertrend indicator is built on this idea.
Remember that a stop does not protect against gaps. ATR-based stops reduce the chance of being shaken out by noise; they do not cap the loss on a large overnight move.
Using ATR to size positions
Position sizing based on ATR keeps the rupee risk per trade roughly constant, whatever the instrument's volatility.
Step 1. Decide the maximum you are willing to lose on the trade, for example ₹5,000.
Step 2. Decide the stop distance in ATR terms, for example 2 × ATR.
Step 3. Divide the rupee risk by the stop distance per share.
Example. With an ATR of 10, a 2 × ATR stop is 20 rupees away. ₹5,000 ÷ 20 = 250 shares. For the calmer stock with an ATR of 4, the stop is 8 rupees away, so the same ₹5,000 risk allows 625 shares.
The more volatile stock gets a smaller position, the calmer one a larger position, and each carries roughly the same risk if the stop is hit at its level. Gaps can still make actual losses larger.
For futures, divide the stop distance by the lot size to find how many rupees a stop represents per lot, and size in whole lots, which may mean taking a smaller position or skipping the trade if even one lot exceeds your risk limit.
ATR with options
Strike context. Comparing the distance to a strike with the underlying's ATR gives a sense of how many typical days' moves are needed to reach it. A strike four ATRs away needs either several days of steady movement or one unusual day.
Compare with implied volatility. ATR reflects realised movement. If option prices imply moves far larger than recent ATR suggests, options may be relatively expensive, and the opposite if they imply much smaller moves.
Expected move versus ATR. The at-the-money straddle price shows the move priced to expiry. Comparing it with ATR scaled by the square root of days is one way to sense-check whether the priced range looks reasonable.
Good habits
Use the same timeframe as your trade. A daily ATR suits positions held for days; intraday trades need ATR from intraday bars.
Recheck after volatility changes. Recalculate stops and sizes when ATR shifts significantly.
Don't confuse low ATR with low risk. Quiet periods often end abruptly, especially around events.
Write it into your plan. A fixed rule, such as risk ₹X per trade with a 2 × ATR stop, removes guesswork and emotion from sizing.
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Frequently Asked Questions
What is average true range?
A volatility indicator that averages the true range over a period, usually 14, showing how much an instrument typically moves including gaps. It has no direction.
How is true range calculated?
It is the largest of: today's high minus low, the absolute difference between today's high and yesterday's close, and the absolute difference between today's low and yesterday's close.
How do traders use ATR for stop-loss?
By placing stops a multiple of ATR from the entry, such as 2 times ATR, so the distance matches the instrument's normal volatility.
How does ATR help with position sizing?
Divide the rupee amount you are willing to lose by the stop distance per share in ATR terms. More volatile instruments get smaller positions.
Does a high ATR mean the price will fall?
No. ATR measures the size of moves, not direction. It rises in both sharp rallies and sharp falls.
Related Reading
- A trailing line that uses ATR
- A trend-momentum indicator
- Sizing positions by maximum loss
- Risk rules every trader needs
- Another volatility measure on the chart
- Gaps that jump past stops
Disclaimer: TheFinBaba provides educational content only - this is not investment advice. Trading involves risk of loss.
