ATR Forex Strategies
Average true range (ATR) is a technical indicator developed by J. Welles Wilder in 1978. Its purpose is to gauge the volatility of a currency pair -- all foreign exchange (Forex) market trades involve a pair of currencies -- such as EUR/USD, the euro/U.S. dollar currency pair. Wilder's thesis was that periods of high and low volatility alternate, and the transition from low volatility to high can be a useful trading signal. The ATR is a moving average of the true ranges (TRs) of a currency pair for a given number of days.
Other People Are Reading
-
Calculation
-
The true range is the price range between yesterday's closing price (CY) and today's high (H) or low (L) price. CY is included in the range to account for gap openings, in which today's opening price is significantly different from yesterday's closing price. The true range is the largest figure derived from these three equations:
TR = H minus L.
TR = H minus CY.
TR = CY minus L.
The maximum absolute value of TR from these three equations is added to yesterday's 10-day moving average to give today's ATR: ATR = (0.9 times yesterdays moving average) + (0.1 times today's maximum TR).
Example
-
Assume yesterday's closing price of EUR/USD was 1.3800, and that today's low and high were 1.3902 and 1.3919, respectively. Yesterday's ATR stood at 0.0042. Here are the three TR solutions:
TR = 1.3919 minus 1.3902 = 0.0017.
TR = 1.3919 minus 1.3800 = 0.0119.
TR = 1.3800 minus 1.3902 = (0.0102).
The maximum absolute value of TR is 0.0119. We apply it to yesterday's ATR as follows:
Today's ATR = (0.9 times 0.0042) plus (0.1 times 0.0119) = 0.0050.
-
Entry Signal
-
The gap between yesterday's close and today's low indicates a volatile currency pair. One position entry strategy is to buy into the currency pair when its price exceeds the sum of the next day's open and today's ATR. If we assume that the next day's opening price of EUR/USD was 1.3921, then our target entry price is:
Target Entry Price = ATR plus Opening Price = 0.0050 plus 1.3921 = 1.3971.
Should the price of the EUR/USD currency pair exceed 1.3971 during the trading day, a buy signal would be generated.
Exit Signal
-
ATR often is used to signal an exit price for a position. For instance, ATR can be used as a stop loss -- the maximum loss that will be tolerated for a given position. In our example, we place a stop loss at the purchase price minus 30 percent of the ATR (0.0015). If we purchased the EUR/USD currency pair at the indicated entry point of 1.3971, we would set the stop loss at 0.0015 below that figure, or 1.3956. Should prices retreat to our stop loss figure, our position would be automatically closed. A similar strategy exists for a take-profit order, which is the minimum gain we are willing to accept on a position.
-
