Average True Range (ATR) Explained: Volatility and Risk
Average true range (ATR) is an indicator of historical price variability built from each period’s high, low and previous close. It is expressed in the instrument’s price units and does not indicate whether prices are likely to rise or fall. An ATR-based stop distance or position size is a risk-management assumption, not a guarantee of execution or a limit on losses.
Why ordinary high–low range can understate movement
A daily high minus low describes trading within that session, but may omit an overnight gap from the prior close. True range therefore takes the maximum of three absolute distances: high−low, high−previous close and low−previous close. This captures the gap in the daily change measure. For markets operating almost continuously, session definitions and weekends still affect gaps.
Worked true-range example
Suppose the prior close is 98, today’s high is 103 and today’s low is 100. The intraday high–low range is 3. The absolute high−prior close is 5, and low−prior close is 2. True range is max(3,5,2)=5 units, reflecting the upward gap. If the prior close were 101, true range would be max(3,2,1)=3. The calculation is descriptive, not a forecast of the next session.
How ATR is smoothed
A conventional 14-period Wilder ATR begins with an average of the first 14 true ranges and then updates as new ATR = (prior ATR×13 + current true range)/14. Other charting packages may use alternative moving averages and initialisation. Because the smoothing looks backward, ATR responds to a new volatility regime with delay. The numerical value depends on price denomination and instrument characteristics.
ATR is not percentage volatility
An ATR of 2 points has different economic meaning for a £20 share and a £200 share. Some analysts normalise ATR by the asset’s price to express a rough percentage range. Even then, ATR and annualised return standard deviation measure different statistical properties. One captures smoothed absolute bar ranges; the other typically uses dispersion of returns. Their values should not be substituted in a risk model without calibration.
Illustrative volatility-based sizing
Assume a hypothetical asset with ATR of £1.50 and an educational stop distance of two ATRs, or £3. A £300 planned price-distance risk would correspond to 100 shares before transaction costs. This calculation does not guarantee that a stop-market order fills exactly £3 away, particularly through gaps. The analysis should also consider whether the resulting notional exposure, concentration and liquidity are acceptable.
ATR and changing volatility regimes
During high-volatility events, true ranges can jump and ATR may rise, implying a wider mechanical distance and smaller position size under some schemes. As conditions calm, ATR can decline. This adaptation can be useful for making assumptions proportional to recent price variability, but it can fail to anticipate sudden jumps after quiet periods. Historical calm does not imply a safe future market.
ATR across timeframes and instruments
A five-minute ATR and daily ATR reflect different intervals, and their values cannot be compared without careful scaling. Equity gaps, commodity futures session breaks and Forex broker candle cutoffs influence the calculations. Futures prices and CFD contracts have distinct point values, so convert ATR distance into currency risk using the actual contract multiplier rather than assuming one point equals one pound or dollar.
How to assess an ATR strategy
Specify true-range calculation, smoothing method, data sessions, stop multiplier and execution rules before backtesting. Test gap scenarios and include costs. Evaluate whether ATR-based rules improve risk consistency versus simple fixed-distance assumptions, while noting that a descriptive volatility indicator does not measure all tail risks.
True range includes a gap that high–low range misses
Hypothetical previous close 98, next session high 103 and low 100, in price units.
Illustrative values only; see the explanation below for assumptions and limitations.
True range is the maximum of high−low, absolute high−previous close and absolute low−previous close. With these assumptions, the three candidates are 3, 5 and 2, respectively. ATR then smooths a succession of such true ranges; it is not a forecast of the next bar’s maximum move. Always state the session convention and instrument point value, especially for contracts where a five-point move does not equal five pounds or five dollars in P&L.
For further learning on this method and its limitations, see ATR and volatility terminology.
Comparing ATR across instruments without confusing price units
ATR is measured in the price units of the chart. An ATR of £2.50 is substantial for a £50 share but relatively small for a £200 share. Dividing ATR by the reference price converts it into a rough percentage-range measure, useful for comparing instruments at different price levels. This normalisation does not turn ATR into return standard deviation, and it does not make trading costs or liquidity equivalent.
| Illustrative share | Reference price | ATR | ATR / price |
|---|---|---|---|
| Share A | £50 | £2.50 | 5.00% |
| Share B | £200 | £2.50 | 1.25% |
The same principle requires attention to quotation conventions for futures and FX. A futures contract’s ATR in index points must be multiplied by the relevant contract multiplier to express cash exposure; a currency pair quoted in pips must be converted using its pip value and the account currency. Treating equal numerical ATR values as equal cash risk would be an error. For portfolio comparisons, also consider volatility correlations and position size rather than ATR alone.
ATR-based stops: distinguish model distance from actual loss
A rule such as placing a hypothetical stop two ATR units away converts recent range information into a price distance. It cannot establish that two ATR units is the ‘right’ risk tolerance, nor that a stop will fill at the specified price. If a £50 share has ATR £2.50, two ATR units imply £5 of price distance; at 100 shares that is a £500 nominal price movement before costs. A gap through a stop, a halt, inadequate liquidity or rapid market moves could produce a larger realised loss. Any sizing method therefore requires explicit cash-loss limits, product specifications and adverse-execution scenarios.
For separate treatments of portfolio cash risk and volatility scaling, read Position Sizing Explained and Realised vs Implied Volatility.
Frequently asked questions
Does ATR show market direction?
No. It measures recent price range variability.
Does an ATR stop cap maximum loss?
No. Gaps and slippage can cause worse fills.
Is ATR identical to annualised volatility?
No. It is based on smoothed true ranges rather than return standard deviation.