Average True Range Indicator Strategies & Techniques: When to use it, When NOT to use it, and WHY

Hey, hey. What's up my friends?

In this video, you’ll learn all about the Average True Range indicator.

Otherwise known as the ATR indicator.

This is one of my favorite trading indicators because it's so versatile.

It has so many users, not many traders know of.

In this training video, I'll talk about:

  • What is the ATR Indicator.
  • How to find explosive breakout trades in the market using the ATR indicator.
  • How to place a proper stop loss so you don't get stopped up prematurely.
  • You’ll learn how to ride massive trends in the market that others can only dream of.

Let's begin…

What is the ATR Indicator

The ATR indicator simply is an indicator that measures volatility in the market.

I repeat…

The ATR indicator measures the volatility in the market:


As volatility expands, the ATR indicator will point up higher.

Because when you look at the range of the candles, they are increasing over time.

You can see it's increasing and finally, we have this huge spike over here that coincides with this increase in volatility:


Basically, in essence, the larger the range of the candles the larger the ATR value is going to be.

One thing to point out is that the ATR indicator does not tell you the direction of the trend.

This is not a trend indicator that tells you whether the trend is going up or down, because as you can see over here:


The market is clearly going higher.

But the ATR value here is going lower.

Because as I've said, the ATR indicator measures volatility in the market.

It looks at the range of the candle.

Over here you can see that the range of the candles is getting smaller.

That's why the ATR indicator, the values here are decreasing.

Moving on…

How do you actually find explosive breakout trades before it happens

One thing to note first is that the market is always changing.

It moves from a period of low volatility to a period of high volatility.

Then it moves from a period of high volatility back to a period of low volatility.

It's like a cycle, like the four seasons.

This is typically how the market moves.

If you have noted this that the market is in the low volatility environment.

There's a good chance that the volatility could expand in the near future.

Pay attention to the ATR value, especially the multi-year low ATR value.

So, this is the weekly timeframe on Brent Crude Oil:

Notice the ATR value has slumped to multi lows.

This pretty much coincides as the market is in the range and volatility is shrinking up to absolute lows.

When the market finally had broken out, it basically had an expansion in volatility which had a move towards a downside.

This is basically where crude oil collects from about $103 down to a low of about $30 or $40.

We can see that the multi-year low volatility is a huge clue to you that crude oil is about to have a big move coming into the market.

This is a crude oil example.

Next example is EUR/USD:

The same concept, looking at the weekly timeframe.

You pay attention to the multi-year low volatility.

The market is in a range.

Volatility is low.

There's not much interest in it.

And when the market breaks down, volatility picked up and basically a very huge move in EUR/USD as well.

Whenever volatility is low, especially when it's approaching or is at multi-year lows, you want to tell yourself that if the market does break out, a big move could follow.

This is a powerful, powerful trading technique.

Moving on…

How do you set a proper stop loss when you're trading

This is where the ATR indicator, again, is so useful.

Often what traders will do is they look at a price rejection:


They go long for whatever reason and put a stop loss just below the swing low.

What could possibly happen is that the market came down lower.

Triggered a stop loss, and then continue higher.

This suck.

I know it sucks.

We can see that historically based on this chart, put your stop loss below the low...

You're going to get stopped out.

Because the market just triggered below the lows and then rallying back higher.

Clearly, you want to set your stop loss away from this obvious level, away from support.

What you can do is to use the ATR indicator to tell you how much buffer you should put as your stop loss.

In this case, the ATR value is about $57 for this market. What you can do is to identify the lows over here and then take the $57 and minus it from the low.

Let's say the low is 5,600.

We minus 57 because this is one ATR, and you get a stop loss of about 5,543.

Your stop loss level will be around 5,543,

Which is one ATR below this low?

The reason why you're doing this is that you don't want the market to just come down lower.

Trigger below the low and then rally up higher.

What you're doing is, in essence, giving your trade, your stop loss, some buffer.

So you don't get stopped out prematurely.

This is how the ATR indicator can help you with it.

Good stuff, right?

Moving on…

How do you ride massive trends in the market using the ATR indicator

One way to go about it is that for example, the ATR value usually is let's say a value of X.

What you can do is that you can use a multiple of X to trail your stop loss.

Let's say for example you want to ride trends and you don't know how much buffer you should give your trade.

If it's too tight you might get stopped out on the retracement.

You're going to give it enough room so you can endure the retracement that comes along with it.

One example you can do is use a 5x, meaning a multiple of 5 as your Average True Range.

If your Average True Range value is $20, multiply by 5.

Your trailing stop loss is basically $100 from the highs.

Let me share with you this very useful indicator called the chandelier stop:


This is basically the same concept which I've shared with you earlier.

What you do is that the chandelier stop would take the highs and it calculates what is the ATR value, otherwise known as X.

In this case, I use 5 as my multiple, so I'm using 5x.

What it'll do is take 5 multiplied by X, and this is the level which is your trailing stop loss.

All you need to do is just to hold on your trade if the market is above this level, which is 5 ATR from the highs.

If the market does not break below if you hold onto your trade, as simple as it is.

This tool is very simple to help you ride massive trends in the market.

Of course, the tighter your multiple the smaller the trend you'll capture.

The larger the multiple that you're using the longer the trend that you will ride.

It really depends on you how big of a multiple that you want to use.

It's a rough general guideline.

If you use a multiple of 3 you tend to capture medium downtrend, anything above 5 or more, you'll capture the longer-term trend.

This is a rough guideline to the multiple that you can consider depending on the type of trends that you want to ride.

One last thing that I want to share with you is…

How to use the ATR indicator to predict a market reversal

This is really cool.

One thing to know is that the ATR indicator; you can think of it as a potential energy in the market.

For example, if you look at the weekly ATR initials, say 300 pips.

What it's telling you that this is based on the historical past period.

The market tends to move about 300 pips over the last few weeks.

If this week, the market has moved let's say, 600 pips, or 500 pips.

It's telling you that it has really exceeded its ATR value.

Its energy (300 pips) has been used up.

If you see a market that has exceeded its ATR value by two or three times, there's a possibility that the market could show signs of reversal.

Here's an example:

This is the GBP/JPY.

The weekly timeframe has about 300 pips on its weekly ATR.

On the candle on the right side, you see that this market has already collapsed 500 pips lower.

You're not going to go long at this point in time.

But it should alert to you that this market has moved 500 pips, where its weekly ATR value is only 300 pips.

In the back of your mind.

You think that the energy in this market has been used up, there could be a possible reversal.

You have to look at clues to the market telling you that it could actually reverse back up higher.

On the daily timeframe:


You see that this market came into this area of support.

Then you have this Bullish Engulfing pattern reversing and closing back above the area of support.

Plus, you saw earlier on the weekly timeframe the market has already moved 500 pips down lower, which is almost two times the weekly ATR.

This should give you a hint that you don't want to be shorting the market anymore.

If you're short, you may want to bail out of their trade.

If you are bullish on this market for whatever reason plus the reasons I've just shared with you, you can look to get long.

Get onto a long site in anticipating of the market about to reverse higher.

This is how you can use the ATR indicator by basically looking at how much the market has exceeded its usual ATR value.

And then with other confluences, like support resistance and Candlestick patterns, you can actually identify good areas on your chart where the market is likely to reverse.

Just a quick recap to what you've learned today…

Recap

  • The ATR indicator measures volatility. It does not measure the trend.
  • The low ATR values on a weekly timeframe could potentially alert you to breakouts that are about to occur. Pay attention to multi-year low volatility.
  • You can use the ATR indicator to set your stop loss. I mentioned that you can use the ATR indicator, set some buffer below the lows as your stop loss.
  • A slight modification to the ATR is basically called the chandelier stop. Basically, it's very useful to actually trail your stop loss to ride big trends.
  • If the market has moved more than 2 ATR into an area of support/resistance it could snap back in the opposite direction.
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