Average True Range (ATR) Indicator - Crypto Academy /S5W1 - Homework Post for kouba01

Question 1 - Discuss your understanding of the ATR indicator and how it is calculated? Give a clear example of calculation

The ATR indicator which is the short for the Average True Range Indicator is basically a technical indicator that measures the market volatility of an asset on average over a particular period of time. The ATR indicator has proven to be effective in measuring price volatility of an asset and is a very powerful for identifying how much the price of any given cryptocurrency asset has fluctuated during a particular period of time. The ATR indicator was developed by J. Welles Wilder and was published in his book that was published in 1978.

The sole purpose for creating the indicator was to measure the price volatility and price fluctuations of an asset on average over a particular period of time. The Average True Range Indicator has a default period length of 14. The ATR oscillator moves between low values and high values. When the ATR value is high, it can indicate that the price fluctuations is high and when the ATR value is low, it can indicate that the price fluctuations is much lower which either mean that the asset is moving sideways or during a period of consolidation.

ATR indicator on the AAVE/USDT Chart

Average True Range Calculation

When it comes to calculating the Average True Range, the True Range needs to be gotten. To calculate the True Range, there are 3 parts that is calculated.

1). True Range = CPH – CPL

Where;
Current Period High = CPH
Current Period Low = CPL

2). True Range = CPH - PPC

Where;
Current Period High = CPH
Previous Period Close = PPC

3). True Range = CPL - PPC

Where;
Current Period Low = CPL
Previous Period Close = PPC

Interpreting the True Range calculations

The first part of the True Range calculation which is the current high minus current low, shows the distance from current high to the current low. This is seen on the candlesticks and is utilized when the current candlestick is bigger than the previous candlestick.

The second part of the True Range calculation which is the current high minus previous close, shows the distance from current high to the previous close. This is seen on the candlesticks and is utilized when the current candlestick closes higher than the previous candlestick.

The third part of the True Range calculation which is the current low minus the previous close, shows the distance from the current low to the previous close. This is seen on the candlesticks and is utilized when the current candlestick closes lower than the previous candlestick.

The Average True Range takes into consideration the MA of the true range using the set period. The default period for the ATR indicator is 14 periods. Using the 14 period ATR, it is calculated as True Range divided by 14.

ATR = max[(CH – CL), abs(H – PC), abs(L – PC)] / 14

where;
Current High = CH
Current Low = CL
Low = L
Previous Close = PC

Using the ATR calculation, the value of the ATR is gotten using the set number of periods. The next ATR can be calculated as follows; using 14 period

Current ATR = [(Previous Average True Range × (period -1) + Current True Range] / period

Let’s take for instance, if the value of the first calculated ATR is 8.5

Let’s take for instance, AAVE/USDT

Previous ATR value = 7.5
True Range = 6.5
Periods = 14

Using the current ATR formula
Current ATR = [(Previous Average True Range × (period -1) + Current True Range] / period

Current ATR = (7.5 × (14 -1) + 6.5) / 14
Current ATR = (7.5 × (13) + 6.5) / 14
Current ATR = (7.5 × 13 + 6.5) / 14
Current ATR = 104 / 14
Current ATR = 7.43

Question 2 - What do you think is the best setting of the ATR indicator period?

In my opinion, the best settings for the Average True Range (ATR) indicator greatly depends on the particular time period for the analysis, whether it is for short-term or long-term analysis and also depends heavily on the trading strategy. However, the default value of the ATR indicator is 14 which is considered very common period for the ATR indicator. However, it is important to know that the periods that is used has a big effect on the smoothness of the ATR line.

Even though the ATR indicator has a default settings of 14, the period can be changed to suit the particular timeframe. For example, it is more ideal to make use of short period length for short-term timeframe, and more ideal to make use of longer period length for long-term timeframe. Longer period length is slower and generates a smoother line on the ATR indicator with fewer trading signals when used on a selected timeframe. Shorter period length is faster and generates a rougher line with more trading signals on the ATR indicator with fewer trading signals when used on a selected timeframe. From the AAVE/USDT chart below we can see the different period length from short period length to longer period length and how it affects the smoothness of the ATR. Short period length produces rougher line on the ATR and longer period length produces smoother line on the ATR indicator.

Question 3 - How to read the ATR indicator? And is it better to read it alone or with other tools? If so, show the importance.

When it comes to reading indicators on a chart, the ATR indicator is one of the easier indicators to read even for beginner because of its simplicity and easy to understand. Since the ATR indicator measures the market volatility or price fluctuations of any cryptocurrency asset at any particular period, it is much easier to read the ATR indicator because areas of high price fluctuations or market volatility on the candlestick charts which usually has large candlestick bodies, reflects on the ATR values which also shows high ATR values and areas of low price fluctuations or market volatility on the candlestick charts which usually has small candlestick bodies reflects on the ATR values which also shows low ATR values.

AAVE/USDT Chart

Looking at the AAVE/USDT chart, we can clearly see that the high volatility area on the candlestick chart which has large candlestick bodies, reflected on the ATR values which shows high ATR values. When the ATR value is increased, it is an indication of high market volatility.

Also, we can clearly see the low volatility area on the candlestick chart which has small candlestick bodies, reflected on the ATR values which shows low ATR values. When the ATR value is decreased, it is an indication of low market volatility. The candlestick chart shows that the area of low volatility is the area where the market was moving sideways or ranging. This signal can be used to make good entry or exit decisions when trading.
AAVE/USDT Chart

Combining the ATR indicator and the RSI indicator

Even though the ATR indicator is a very powerful technical indicator on its own for measuring market volatility and price fluctuations in the market over a given time period, it is also very important to combine it with other technical indicator for better reading and effective indications because there is no indicator that is perfect in its signals and there is always false signals. RSI is a very good and common technical indicator that can be used in combination with the ATR indicator for more effective indications.

The RSI indicator is basically a momentum indicator that indicates overbought and oversold in the market. The RSI oscillator line moves between 0 and 100. 30 and 70 are the main values of the RSI indicator. When the RSI oscillator line moves below 30 value, it is an indication that the market is in oversold, and when the RSI oscillator line moves above 70 value, it is an indication that the market is in overbought. When the price ranges between 30 and 70, it is an indication that the market is neither overbought or oversold and is neutral.

The RSI can become useful in combination with the ATR indicator because if the RSI value is above 70, there is a strong possibility of reversal in the market as there will be more sellers in the market selling to take profit. This would reflect in the ATR as high volatility since there will be rapid price movements. From the chart, we can see that the area where the ATR indicator has a high value and indicates high market volatility, the RSI indicator indicates an overbought and what followed next was a price reversal. Also in the area of low volatility in the market with small candlestick bodies ranging, the RSI indicator also indicates a ranging market with the oscillator line ranging between 30 and 70 values.

Question 4 - How to know the price volatility and how one can determine the dominant price force using the ATR indicator?

When it comes to the ATR indicator, it is already known that it indicates market volatility and price fluctuations which is seen on the candlestick chart with a big body candlestick that either moves upwards or downward, with an increased ATR value. On the ATR indicator, there is a notable increase in value when the market is moving in a strong bullish or bearish direction which causes a rapid spike in the price of the asset either upwards or downwards. When the ATR value is low, there is reversal upwards.

On the BNB/USDT chart, we can see the area of price volatility as the ATR has a high value andthere is a big body candlestick. On the Chart, the point where the price of BNB was at $507 which was at a high, the ATR indicator also indicated low volatility. As there was a big drop in the price of BNB which saw the price fall from $507.1 down to 390.2, there was a huge increase in the ATR value which indicated that there is a high market volatility. After the ATR indicator experienced an spike in value, it gradually decreased back to the low value which was an indication of low volatility in the market. This can be a good trend reversal signal because we can see from the chart that the point when there was a huge increase in the ATR value, the market entered into a bearish trend. Traders can make use of this signal as a sell signal.

BNB/USDT Chart

Determining the dominant price force

It is already clear that when there is price volatility on a chart with big body candlesticks, the ATR indicator also reflects that with an increased ATR value. Regardless of the trend, whether it is bullish or bearish, as far as there is a notable price volatility, the ATR indicator should have a huge increased spike in its value which determines the dominant price force. With this the trend can be determined when there is a corresponding ATR value.

From the BNB/USDT chart above, the price of BNB was rising but the ATR indicator was indicating that there is a low volatility with a decreasing ATR value. As a result of this, we can deduce that the price moving in an upward direction doesn’t relate to the dominant force on the price. This can mean that the bullish momentum isn’t strong enough to continue the upward movement. Also, it proved that there was no dominant force that caused the increase in price. What followed next was an increased spike in the ATR value and the price corresponded with that with a rapid fall in the price of BNB. This means that the sellers are still in control of the market and dominant force is bearish. With this, traders can avoid making bad trading decisions due to fakeouts that occurs in the market.

BNB/USDT Chart

We can also see above that in the area where the price of BNB was falling gradually, there was a decreasing ATR value which indicates low price volatility. From this, we can deduce that the price moving downwards doesn’t relate to the dominant force on the price. This can mean that the bearish momentum isn’t strong enough to continue the downward movement. Also, it proved that there was no dominant force that would continue pushing the price downwards. What followed next was an increased spike in the ATR value and the price corresponded with that with a rapid rise in the price of BNB. This means that the buyers have taken control of the market and the dominant force is bullish.

Question 5 - How to use the ATR indicator to manage trading risk?

When it comes to trading any cryptocurrency asset, risk management is super important as it can be a key factor to how much loss is incurred or how much profit is made on any given trade or investment. As far as trading is concerned, price volatility is what leads to profit or loss. Since the ATR indicator is an indicator that measures price volatility, it can be a great tool for risk management when it comes to trading any cryptocurrency asset.

Stop loss strategy

The stoploss is a powerful risk management strategy that helps to reduce losses if a price goes against the trader. It is known as an exit strategy and has proven to be a game changer for a lot of traders because it allows traders to go into the market without much fear of losing too much of the capital if the price goes against the trader. Without stoploss, a trader can lose all the capital if the price goes in the opposite direction as forecasted. A good strategy for using the stoploss is that it should not be too small from the entry price that it triggers easily and not be too large off the entry price that it incurs bigger loss if the price goes against the trader due to high market volatility. The ATR indicator is a great tool that can be used as a stoploss strategy when trading.

To illustrate this on the BNB/USDT;
Using the StopLoss: Entry Price - 3x ATR Value, I want to place a buy entry at the price of BNB/USDT is 585.9 and the ATR value is 21.7. To get the stoploss,
Stoploss = $585.9 - (3 × 21.7)
Stoploss = $520.8

Take profit strategy

The take profit strategy is also a powerful risk management strategy that helps to secure profit and reduce the risk of losing all the profits made due to high market volatility. When a trade is in profit, the take profit is important because it helps close the trade and secures profit. It is also an exit strategy and has proven to be a game changer for a lot of traders because it allows traders to go into the market with confidence to secure profit when the trade is favorable. Once set, the trader don’t need to monitor the market as the take profit will automatically trigger once the price condition is triggered. Depending on the trader’s strategy, a good strategy for using the take profit is that it should not be greedy that in the absence of the trader, the price doesn’t hit the trader’s take profit mark but rises significantly and returns downwards, and also should not be too small that the trader gains very little and misses out on bigger gains from continuous price increase. Like the stoploss, the ATR indicator is also a great tool that can be used as a take profit strategy when trading.

To illustrate this on the BNB/USDT;
Using the take profit: Entry Price + 3x ATR Value, I want to place a buy entry at the price of BNB/USDT is 585.9 and the ATR value is 21.7. To get the stoploss,
Stoploss = $585.9 + (3 × 21.7)
Stoploss = $651

Question 6 - How does this indicator allow us to highlight the strength of a trend and identify any signs of change in the trend itself?

A trend can be identified when there is a continuous price movement in a particular direction either uptrend or downtrend. The ATR indicator is a very powerful indicator that can be used to strength of a trend and also trend reversal signs. Like we all know, in the area of high market volatility which is represented on the chart with big body candlesticks moving upwards or downwards, the ATR indicator shows a corresponding spike in the ATR value as it shows that there is strong dominant force that pushes the price upwards or downwards. This can become very powerful in highlighting the strength of a trend.

From the BNB/USDT chart, we can see that there was a resistance level at around the 445.5 price point. We can see that the ATR value was decreasing in a downward slope. The price of BNB finally broke above the resistance level and we can see that the ATR value corresponded with the resistance breakout with a huge spike in the ATR value. This means that there is a possibility that buyers are about to take control of the market and that the buying pressure is about to become the dominant price force.

Change in Trend

Trend reversals is one of the signals that can be observed on the chart and the ATR indicator is also a great tool that can help signal potential trend reversal in the market. When the market is moving sideways or ranging, it simply means that there isn’t any dominant force present and that there is indecision in the market. This can mean that there is a potential movement upwards or downwards. When there is a sideways movement is after a downtrend, it can be a strong indication that the downtrend momentum is weakening and there is a potential upcoming reversal.

On the chart, we can see that in the area where the price was moving sideways after a downtrend, The ATR indicator also corresponded with a decreasing downward slope from high volatility to low volatility. This means that there downward dominant force has lost its momentum. After that, there was an increasing upward slope on the ATR indicator which was a strong indication that the buyers are about to take control and that there is a presence of a dominant price force which corresponded with the increasing ATR value.

Question 7 - List the advantages and disadvantages of this indicator

Advantages

• One of the main advantages of the ATR indicator is that it is very simple and easy to use and read by anyone.

• It can provide good signal for entry and exit when combined with other strategies or indicators.

• It offers flexibility which means that it can be combined with other technical indicators to confirm signals so as to make better trading decisions.

• Can be used as a risk management strategy to set stoploss and take profit points when trading any cryptocurrency asset.

• It can be used on any timeframe and still generate good signals.

Disadvantages

• It isn’t not known for providing direct buy and sell signals singlehandedly

• It has to be combined with other strategies and technical indicators to make the best use of the ATR indicator

• It is very difficult to tell what is happening in the market just by looking at the ATR indicator alone

• The ATR indicator only measures volatility in the market and cannot just tell the direction the market will go on its own.

Conclusion

The ATR indicator has proven to be a very powerful and simple to use indicator when it comes to technical analysis and cryptocurrency trading. The ATR indicator has proven to be effective in measuring price volatility of an asset and is a very powerful for identifying how much the price of any given cryptocurrency asset has fluctuated during a particular period of time. Because of this, it is very popular among traders for indicating market volatility. However, it is important to know that the ATR indicator is not perfect and should be used in combination with other technical indicators and trading strategies to make the best use of the indicator and make better trading decisions.