Average True Range Is A Fantastic Measure Of Volatility And Market Noise
February 28th, 2007You 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 determines a security’s 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 security’s price movement. A more useful period to use for the average true range would be 14.
To read more, go to the Average True Range website by clicking on this link.
