Trading Forex With an ATR Indicator

The Average True Range (ATR) indicator is a very popular indicator invented by Welles J. Wilder, the technical analysis author which has invented many trading indicators like the Relative Strength Index and the Parabolic SAR. The ATR is one of his least popular indicators as it does not generate objective trading signals. In this article you will learn how to make the most of this FOREX indicator.

The ATR is a unique indicator in the idea that it does not attempt to generate trading signals - but present the market volatility. The ATR shows the average volatility (range of candle) in last 14 bars.

The main methods of trading with the ATR in FOREX are the following:

Method #1: Calculating Stop Loss

The first method of using the Average True Range indicator in FOREX, is in calculating stop losses. When designing a trading system, either automatic or manual, one needs to work on making the system universal - profitable on as many pairs. In order to make a system profitable in several pairs, one needs to fit the system to different volatilities and characteristics of the FOREX pairs. What is a better way of fitting a system, than making it fit itself? Using the ATR, one can make the system automatically adapt itself to pairs with different volatility, and therefore work without manual intervention in different pairs.

For example: Instead of setting stop loss as a constant number (e.g.: 20 pips), set the stop loss in terms of ATR: 150% ATR. This makes the stop loss be at the size of 1.5 times the ATR. Implementing such attitude in your systems will cause them to be much more adaptive and work on many pairs without need to manually optimize them.

Method #2: Identifying Reversals

The second method is a more practical approach that is used by traders to identify bottoms and tops. The basis of the method is the idea that when the Average True Range is in a minimum (creates a bottom), price is at a reversal point. Traders should pay attention to the values of the ATR, and be careful of reversals at price if the ATR is creating a bottom.

Method #3: Strength Of Trend

As a general rule of thumb, a low reading of the Average True Range indicates that the trend is weak. High readings of the ATR indicate that the trend is strong, that the candle range are increasing and price is gaining momentum. This is useful to gauge the trend strength before entering a trade - if the ATR is decreasing, it can be a sign that trend is losing strength and that an entry is risky.