Understanding ATR indicator

Volatility is frequently used to describe the degree of risk or uncertainty associated with the extent of variations in a security value. A security price can fluctuate in any direction because of market forces, i.e., Demand and Supply. High volatility means the price of security can fluctuate sharply over a short period of time. Lower volatility refers to stable movement rather than dramatic fluctuations. 

Now that we have understood what volatility is, let’s learn what the ATR indicator is and learn how to measure it. 

Key takeaways 

The Average True Range (ATR) is a volatility indicator. Traditional volatility calculations often look at the range between the current High and Low. However, this method misses price gaps—situations where the market opens significantly higher or lower than the previous close due to overnight news or events. 

The ATR indicator is unique because it accounts for these gaps (Gap Ups and Gap Downs) in its calculation, providing a 'True' measure of market volatility. Refer to the description below to understand gaps. 

Security has a gap down when its opening price is lower than its prior day's closing price.  

When security begins at a higher price than it closed on the previous day, this is known as a gap-up. 

The ATR indicator calculates the true range of security and its average and helps the trader to bridge gaps and organize trades more efficiently. The price or trend direction are two things that the ATR won't reveal to you. Simply put, that's not what the indicator was intended to do.  

The ATR was created by J. Welles Wilder for the commodities market, but it can also be used for stocks, futures, options, and currencies, as every other technical analysis tool. 

How to apply ATR on charts?  

Just like every other indicator, first, click on the indicators section of your charting platform and search for ATR or Average True Range. A single click on the indicator and you will have ATR in action. Refer to the picture below for a better understanding. 

Now that we have understood the meaning of the indicator, let’s learn the practical application of the ATR indicator. 

Unlike indicators such as RSI, the ATR is not bound between 0 and 100. Instead, the ATR value is relative to the price of the asset. For example, a stock priced at ₹10,000 might have an ATR of 200, while a stock priced at ₹100 might have an ATR of 5. Therefore, you cannot use a fixed number to define high or low volatility. 

To determine if volatility is high, traders compare the current ATR value to its own historical average. If the current ATR is rising, volatility is increasing. Ideally, for intraday trading, traders look for rising ATR values to ensure there is enough movement to generate profits. This logic can be applied to any timeframe, whether it is 5 minutes, 15 minutes, or daily charts. 
Also read, What is Relative Strength Index (RSI)? 

What does the ATR indicator tell you?

The ATR indicator helps traders understand market volatility by showing how much a price typically moves over a set period. It does not indicate direction, only the strength of movement. 

Traders use ATR to plan entries, set stop losses, manage position size and confirm whether a breakout is reliable. 

How to calculate the ATR Indicator value? 

There are 3 major components required to calculate the ATR indicator value.  

The highest TR value among them will be used to determine the ATR. 

After doing this we will get done with the first set of true ranges, but the ATR is an average of true ranges over a period of time. For calculating the value of 2nd set onward, we can use the formula given below. 

ATR Formula Calculation = {[First ATR x (n-1)] + Current TR} / n 

This calculation will give you values that are solely subjectively categorised as high or low. The reason this value indicates volatility, not direction. Higher the value, the higher the volatility. Lower the value, lower the volatility. 

How to determine Stop Loss with the ATR indicator? 

One can determine the Stop Loss by using a multiple of the ATR value (commonly 2x or 3x). For example, when taking a bullish trade, you can subtract 2x the ATR value from your entry price to set a stop loss. Conversely, for a bearish trade, add 2x the ATR value to your entry price. Let’s take an example to understand it better. A share was trading at 1000 Rupees with an ATR indicator value of 20 at that time. The Stop Loss for a bullish trade will be 960 and for a bearish trade, it will be 1040. 

Advantages of using ATR 

The ATR indicator offers several practical benefits, especially for traders who want to understand volatility and improve decision-making. It forms a key part of learning how to use ATR in intraday trading, as it adapts naturally to changing market conditions. 

ATR provides a clear reading of market volatility by showing how much price typically moves. Higher values indicate wider ranges, while lower values reflect steadier conditions. 

Traders often use a multiple of ATR to place dynamic stop-losses that adjust to volatility, reducing premature exits caused by normal price swings. 

Rising ATR values during a move can help validate stronger trends, while falling readings may signal consolidation or fading momentum. 

Understanding how to use ATR in intraday trading enables traders to size positions more effectively, taking smaller trades during volatile periods and slightly larger ones when markets are calm. 

Limitations of ATR 

While the ATR is widely used for assessing volatility, it comes with certain restrictions that traders must understand before applying it to ATR trading strategies. Since it measures only the degree of price movement and not its direction, it should always be paired with complementary tools to build a complete trading framework.   

These factors become especially important when traders rely on ATR for entries, exits, or risk adjustments in ATR trading. 

ATR focuses solely on volatility and does not indicate whether the market is trending upwards or downwards, making it insufficient for directional decisions. 

It is derived from historical price data, which means ATR reacts after volatility has already increased or reduced. 

Strategies that require precise directional cues or extremely low-latency signals may find ATR less effective. 

ATR values can change significantly depending on the chosen look-back period, potentially altering trade interpretations. 

Conclusion 

The ATR indicator is a beneficial tool for analysing market volatility and making better trading decisions. While it cannot predict price direction, it does provide traders with critical insights into how much an asset generally moves, allowing them to establish better stop-losses, assess breakout strength, and manage risk more efficiently. Traders can better adjust to shifting market circumstances by incorporating ATR into their strategy, taking cautious bets during periods of high volatility and capitalising on opportunities during periods of stability.  

Though ATR has limits and should be combined with other indicators, it is still an important part of a well-rounded trading strategy. Now that you have understood the meaning and use of the ATR indicator, open Demat Account with Angel One and start building wealth with this powerful indicator.