Average True Range (ATR)
The ATR was invented by J. Welles Wilder in the late seventies. It is a volatility indicator. When the volatility of the market increases, the ATR line goes up. This indicator analyses the volatility of the asset. When the market is rather ranging, it remains low. However, when the market starts moving quickly in one direction, doesn’t matter if it’s up or down, the ATR will start rising. It can be a very good indicator to spot when the big investors are entering the market to buy or sell. We have added a moving average of the ATR line to generate signals. In this way, when volume starts flooding the market and the volatility peaks, the ATR line will rise above its moving average. Likewise, when the volatility falls and the market ranges, the ATR line will fall below its moving average. Last but not least, unlike with other indicators, the ATR does not generate buy or sell signals since it measures the volatility of the market. Therefore, the price can be going up or down. Then, how can you use this indicator in your automated strategy? It can be described as a volatility filter. When the ATR line goes above the moving average, the market is more volatile and the price is moving, then the ATR will let another indicator(s) to give a buy or sell signal. However, when the volatility is low and the price is ranging, the ATR is below its moving average, and it won’t let another indicator(s) to give any buy or signal. Therefore, it filters out trades when the market volatility is low and the price doesn’t move much and let your strategy trade when the market is volatile and the price is trending.