This is Season 5 Week 1 of Steemit Crypto Academy and I'm writing homework task about " Average True Range (ATR) Indicator  " assigned by Professor @kouba01

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ATR is a technical analysis indicator developed by J. Welles Wilder Jr. the basic purpose of using ATR indicator in price chart is to assess the market movement on the basis of the volatility of an asset within the specified period of time.

In simple words ATR is used to assess the pace of the movement of the price of an asset with a specified time frame. The traders use the data obtained from the ATR to initiate or terminate their trades at the right time.

On a 24 hour chart the volatility of the asset is calculated after every 24 hours and the ATR is the Average of all those results of the price movements within that time frame.

The indicator was originally developed to be used in the commodities charts but is now widely used by crypto traders to assess the market movement and volatility. The market is said to be non-volatile when the price makes less changes over a period of time. In addition to that, the market is said to be volatile when price goes up and down rapidly in shorter time frames.

Calculation of the ATR

To calculate ATR we first have to find a number of TRs or true ranges then we take their mean in order to find an average value which is then used to plot a graph. To calculate the true range the following operations are performed.

• Current high minus current low

• Current high minus previous close

• Current low minus previous close

of the above three calculations the highest value is selected as the true range. These values are calculated for every high and low in a selected time frame and then their mean gives us the ATR.

Generally we use 14 periods as used by the developer and then we use the following formulae to calculate ATR

TR= MAX (H-P), Abs (H-Cp ), Abs(L-Cp)

ATR=1/n (summation of all TR)

Here n =14

Example

If for any asset 

Current high is = 13

Current low= 11.5

Previous close= 12

Then 

Current high minus current low= 13-11.5=1.5

Current high minus previous close=13-12=1

Current low minus previous close=11.5-12= -0.5

TR= 1.5

ATR= (Previous ATR * (n - 1) + TR) / n

If the previous ATR is taken as 33 then 

ATR= 33(13+1.5)/n= 34.17

All such TRs during the 14 period time frame are added and are then divided by 14 to get the ATR.

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The recommended and widely used setting period are the 14 periods. Small periods give unreliable signals and too longer period buffers many important trade signals as in longer periods we only have too strong signals.

Below we have a demonstration of two different time periods with ATR.

In the chart above we are using the 4 time period of ATR and we can appreciate the formation of fake and noisy signals that are not too reliable. The price is still trending up when the ATR is showing unnecessary highs and lows.

On the contrary here when we selected 200 periods for a market of 1 hour time frame the ATR became insensitive to the market moves. Thus too long a time period is not too beneficial for the trader. 

It is important to understand that the choice of setting can be varied depending upon the trading settings and type. For short term traders a setting of 10 to 20 periods is generally suitable yet for long term traders a setting between 50 to 80 periods works well.

The 14 periods setting is the default setting which can be changed based on the trading style. It is important to note that these periods actually change the sensitivity of the indicator.

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Since it is graphically denoted in the form of a single line in the charts that correspond with the movement of the chart the ATR is very easy to read and understand. It is less confusing than many other indicators as it complies with the price changes for example a higher ATR means higher volatility and lower ATR means lower volatility. It does not tell you the direction of the market but only the price volatility. So during a strong upward or downward movement the volatility seems to be increased. Its movement is in repetitive cycles which means when it moves high it also comes back to lower levels and vice versa.

We mostly use a combination of indicators with ATR to take a more accurate signal; these may include the CCI, SAR, RSI or Zig zag that give price and momentum direction alerts. For example in the XRP/USDT chart below we have added SAR to see if the volatility complies with the change in the momentum.

It is similar to the concept that you cannot alone use volatility to predict the next market moves. Like you should not just sell your asset when you see that the price has climbed and seems to be higher than the average. ATR should only be used to filter and confirm signals.

In the chart above we see a difference in the two bearish trends which lie in how fast the price changed from there. The first highlighted zone in green was a bearish trend with lesser volatility than the next highlighted yellow bearish zone. The combination of the SAR helps us to make a more decisive approach over the market when placing a bid. 

With SAR you take buying signals when the SAR line is moving above the price and indicating an uptrend and take short signals when SAR is moving below the price line. 

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The price volatility on the ATR is represented by corresponding spikes. Higher ATR readings indicate higher volatility and lower readings indicate lower volatility. As the price makes upward and downward turns the ATR shows peaks or spikes generally and that indicates the changes in price movement and the strength of the force responsible for price changes. 

Sometimes even when the price shows change in the trend or highs and lows the ATR shows a parallel line this indicates that the force behind the price change is not that powerful.

As we know ATR moves from its minimum to maximum and maximum to minimum value during a period. So when there is volatility in the price we also see a change in the ATR reading. In the chart below we see a price volatility which also affected the ATR line. Indicated by the green box we see a price peak. The ATR value then moves toward its minimum value.

 

After the price peak we saw the price action to be less volatile showing lesser peaks. The ATR also then showed a base or flat line. Thus we conclude from here that the movement of the ATR is directly proportional to the volatility in the price of an asset.

This should not be confused with an increase in the price. Increase in price does not necessarily increase the ATR rather an increase in the ATR value indicates the dominant force behind the price change.

In the chart below we see that even when the price dumped down the ATR showed an increase showing the market is volatile and the force of at the point is toward the bearish trend.

Whereas in the other two bullish trends when the price moved up the ATR moves down this showed that the bullish trend at that time is yet not dominant and therefore it is not supported by the ATR. This thus helps us to assume the dominant force by simply comparing the price action movement and the movement of the ATR.

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ATR can be used to place right stop loss and take profit levels and thus helps in risk management. It is pertinent to set these two levels before entering a trade position that ensures less risk and calculated losses in case the price does not perform as expected.

The stop loss is particularly important to not lose more than you can bear.to place stop loss using the ATR we first have to decide the extent such as the 1xATR, 2xATR, or 3xATR. To calculate the stop loss price, subtract the entry price from your set level.

For example

If we calculate the stop loss price based on the TRX/USDT chart below by setting the 

Stop loss level=3×ATR

With ATR=0.001988

Entry price= 0.0108920

Then;

3×ATR = 2× 0.001988 = 0.005964

Stoploss price = Entry price - stoploss level (3×ATR)(0.005964)

Stoploss price = 0.0108920 - 0.005964

Stoploss price = 0.004928Take profit levels are equally important when setting a risk profit. Pre-set take profit levels save us from sudden price fluctuations and also from getting too greedy.

To calculate take profit we first multiply on the above case keeping the take profit to three times of the ATR we can say that 

The profit with the same entry price will be 0.015892 because it is calculated by adding the number of times of ATR we selected to the entry price.

The data can be represented on the above chart as

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I already explained this part of the in the previous questions that ATR helps understand the strength and dominance of the trend. If there is high volatility either in an uptrend or downtrend the ATR value is higher and when there is low volatility the values are lower.

Usually after a strong resistance is broken by an upward price action we see an upward price volatility which is maintained by higher buying pressure and thus higher ATR values. Similarly after a strong support is broken for a downtrend we see an increase in the ATR value indicating that the price action is supported by a higher selling pressure.

We can use ATR movements that are cyclic to therefore ascertain trend reversals.

In the TRX/USDT below we see that the initial trend was bullish but with every top formed the ATR did not show appreciable high. it indicated that the trend was losing strength and we could access it using the spike in ATR. The last top in the price action was more of a correction but did not persist longer the trend according to the prediction of ATR reversed and we saw a large ATR spike indicating that the force of the market is currently supporting a bearish trend.

Thus during a continuous trend the decreasing spike height of the spikes of the ATR show the trend is weakening and a trend reversal can be expected.

Another way to locate trend reversal is to check for the movement of the ATR. If it reaches a maximum value then moves down and is moving continuously near its minimum it can be expected to turn back to its maximum value and thus indicating a reversal soon.

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Following are some of the advantages and disadvantages of the ATR:

Pros:

• It helps in direct assessment of the volatility of the crypto pair. As higher ATR indicates higher value and lower ATR represent lower volatility.

• ATR is widely used in placing right stop loss and take profit signals and thus help in management of the risk during trading.

• The ATR is very easy to understand and interpret

• It helps in placing accurate entry and exit points when used and combination with other indicators as they may be used to predict trend reversals

• Users have the freedom to adjust according to different trading styles. Scalpers can use shorter periods while on term traders can use longer frames

Cons:

• It cannot be used alone to identify entry and exit signals

• The indicator cannot predict future movement of the price of the asset

• It may give false signals when used with shorter periods

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I have learned a lot about that ATR Indicator after doing Homework task this week. Now, after completing this task, I must say that ATR is a reliable indicator when it comes to understanding price volatility of an asset. It can also be used to estimate the strength of the trend and trend reversals. It is recommended to use ATR with other indicators to get accurate results.

CC:

@kouba01

Club5050 Eligible

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