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Trading ATR - Part 3

The document discusses using the average true range (ATR) indicator to manage volatility and identify trend changes in the market. It proposes a "sliding ATR entry condition" that adjusts the trade entry range based on changes in the ATR line value. This allows entries closer to the current ATR rather than waiting for prices to rise or fall to the fixed ATR value. The document also describes combining short-term and long-term ATR calculations to generate trade entry signals, waiting for the long-term ATR value to rise above the short-term ATR in a downtrend as a confirmation of an emerging uptrend.

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Raja Raj
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273 views

Trading ATR - Part 3

The document discusses using the average true range (ATR) indicator to manage volatility and identify trend changes in the market. It proposes a "sliding ATR entry condition" that adjusts the trade entry range based on changes in the ATR line value. This allows entries closer to the current ATR rather than waiting for prices to rise or fall to the fixed ATR value. The document also describes combining short-term and long-term ATR calculations to generate trade entry signals, waiting for the long-term ATR value to rise above the short-term ATR in a downtrend as a confirmation of an emerging uptrend.

Uploaded by

Raja Raj
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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TRADING AVERAGE TRUE RANGE part 3

By Daryl Guppy
Managing volatility is the most significant
INDICATOR REVISION
AVERAGE TRUE RANGE
challenge in changed market conditions. The
The average true range (ATR) increasingly common shorter, sharper trend
indicator was developed by Welles Wilder. behaviours and extended rallies require
It is a measure of the true ranging activity of management based on price volatility, but these
a stock. Most times when we talk about measures need to be more sensitive to volatility
range we mean the difference between the developments to ensure profits are kept and not
high and the low for the day. This gives us diminished by stops that are placed too far below
an idea of how volatile the stock is. This the current price action.
measurement does not tell us who is in The traders’ application of the Average
charge of the price – bulls or bears.
True Range (ATR) captures price volatility, defines
The ATR indicator measures only
the range of prices set by the strongest
the emerging trend breakout and provides a
players in the markets. It does this by method to manage the developing trade. Our
comparing the distance from yesterdays purpose is to use the ATR calculation as a stop
close to today’s high, and the distance from loss designed to protect capital and identify the
yesterdays close to today’s low. This is end of one trend and the beginning of another. We
combined with the distance from today’s use the ATR as a method to identify and confirm
high and low. These figures are averaged trend changes. Later we want to use the ATR as a
to give the Average True Range of price protect profit stop deigned to protect profits and
movements between the end of yesterdays’ identify the end of a trend. In extended rallies it
trade and the close of today’s trading.
can be combined with the CBL line to provide a
series of alert and confirmation exit signals

SLIDING ATR
When the traders ATR is displayed on a chart using the Guppy Traders Essentials
charting package it provides a clear and elegant solution for managing the trend. However, the
value of the ATR is often well below the current price activity. This creates a problem for trade
entry planning. Ideally we prefer an entry close to the value of the ATR line. When we use CBL
for entry method the price is often very near to the CBL value. With the ATR line use din this
way it may take days or weeks for the price to move near to the ATR value.
The solution is a sliding ATR entry condition. This is applied to an established trend. It
starts by identifying a compatible trend and evaluating the average distance of price above the
ATR value. Price has a higher probability of moving into this area and a lower probability of
falling below this area. The trade risk and reward calculations are based on an entry within the
trading range. This may require a reduction in position size as the ATR stop loss may be some
distance from the entry price.

The illustration in figure 22.7 shows an example of this entry method where the entry
range is always 0.80 cents and always calculated from 0.50 above the value of the ATR line.
When the value of the ATR line changes the trade entry range is then adjusted. Traders wait for
the price rebound behaviour to develop before the trade is entered. Aggressive traders may
decide to pay a little bit higher price if the trend rebound is strong.

COMBINED ATR ENTRY

The count back line indicator follows the downtrend and gives an entry signal when price
closes above the value of the CBL line in a down trend. This signals a change in the volatility of
price in the existing downtrend and points the way to a higher probability of trend reversal.

This same logic is applied with the ATR. The downtrend is followed using the short-side
calculation for the ATR. The ATR line continues to fall until there is a closing price higher than
the value of the short side ATR. This is a signal to close short positions and the closing value of
the ATR provides a reverence point for a potential new uptrend. This is not an automatic stop
and reverse process. A close above the short-side ATR is a signal the short trade is closed. It is
not a signal to open a long side trade.
As shown in figure 22.8, traders start a long side ATR calculation. The entry signal is
generated when the value of the long side ATR is higher than the closing value of the short side
ATR. This is area A on the chart extract.
The down trend is defined with the 1*ATR short side trading indicator. This is a 1*ATR
calculation using a 7 day moving average period. It is used to define long term down trends.
Traders wait for the price to move above the 1*ATR short side line. The entry signal is when the
1*ATR long side trading indicator value is very near to, or above the value of the 1*ATR short
side indicator value. The objective is to enter the trade when the price rebound from near the
value of the 1*ATR long side line. The price sometimes dips below the ATR line but closes
above the ATR line and develops up momentum on the next day. This is a entry opportunity.
Waiting for this condition increases the probability the trend change is genuine. Traders
can apply a sliding ATR entry technique or join the trade at the best possible price in the days
following the trend breakout confirmation. We look at these next week, in the final of these ATR
notes.

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