

The Average True Range
Is An Awesome Measure Of Volatility And Market Noise But What
Makes It So Fantasic For Setting Stops?
Provided By Trading
Secrets Revealed
You may have read that many traders use the average true range for
setting their stop losses. The reason is that the average true range
is a fantastic measure of volatility and market noise.
Very simply, the average
true range (ATR) determines a securitys volatility over a given
period. That is, the tendency of a security to move, in either direction.
More specifically, the average true range is the (moving) average
of the true range for a given period. The true range is the greatest
of the following:
The difference between the current high and the current low
The difference between the current high and the previous close
The difference between the current low and the previous close
The average true range is then calculated by taking an average of
the true ranges over a set number of previous periods. Care should
be taken to use sufficient periods in the averaging process in order
to obtain a suitable sample size, i.e. an average true range using
only 3 periods would not provide a large enough sample to give you
an accurate indication of the true range of the securitys price movement.
A more useful period to use for the average true range would be 14.
The value returned by the average true range is simply an indication
as to how much a stock has moved either up or down on average over
the defined period. High values indicate that prices are changing
a large amount during the day. Low values indicate that prices are
staying relatively constant. Note that both trending and level prices
can have high or low volatility.
So, how can we use the average true range in calculating our stop
loss? All you do is you subtract a multiple of the average true range
from the entry price. I might take two times the average true range
and subtract it from my entry price. For example, if we had a one
dollar stock and its average true range value was five cents, I would
simply take a multiple of the average true range, which I said well
use two in this example, and wed subtract it from our entry price.
So, two times our average true range is ten cents, subtracted from
our entry price gives us a stop loss value of 90 cents.
Now, by adhering to this predefined point at which I sell, I know
that if the share price doesnt move in my favored direction, and
actually moves against me, I already know the point at which Im going
to sell. My emotions are removed from the equation, and I just simply
follow what my stop loss says. This is how most successful traders
limit their losses. They know when theyre going to sell and they
have this predefined before they even begin trading. Although their
methods of calculating the average
true range and the stop loss may be different the one common element
here is that they have a stop loss in place.
Heres a little extra finesse point that you might look at including
in your trading plan. I sometimes introduce a time stop depending
on the type of system Im trading. This type of stop simply takes
you out of a position after a fixed amount of time if I havent made
enough profit.
To successfully implement this type of stop, youre going to have
to work out the average true range and do some sort of back testing,
to find out if its appropriate for the particular instrument youre
trading. I just thought Id throw that in there to make sure you have
all your bases covered.
When you first begin calculating your average true range and outlining
your stop losses, just keep in mind what Tom Baldwin, the successful
trader said. He said the best traders have no ego. You have to swallow
your pride and get out of your losses. Hes simply referring to having
a stop loss set, and more importantly, having the discipline to stick
to it.

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True Range www.metaformula.com

