Two stocks can both be worth 100 and behave completely differently: one moves a few cents a day, the other several euros. Knowing how much a stock usually moves is basic information for deciding where to place a stop, how much to invest and what counts as a "big" move. The Average True Range (ATR) measures exactly that.
The true range
The simplest measure of a day's movement is the range: the session's high minus its low. Its problem is that it ignores what happens between sessions. If a stock closes at 100 and opens the next day at 92 after bad news, the day's range can be small even though the stock has moved 8%.
J. Welles Wilder, the same author as the RSI, solved this in 1978 with the true range, the largest of three distances:
- Today's high minus today's low.
- Today's high minus yesterday's close.
- Yesterday's close minus today's low.
That way a gap between sessions counts as movement, which is what it is.
The ATR
The ATR is the average of the true range over the last sessions, 14 in the classic setting. It is expressed in the stock's currency: an ATR of 2.5 means the stock has moved, on average, about 2.5 a day recently.
It is not a direction indicator. It does not say whether the stock will go up or down; it says how much it is moving.
- 1Small candles: the stock barely moves each day and the ATR falls.
- 2Long candles and gaps between sessions: the ATR rises. The same fixed stop would be hit by noise alone.
ATR % to compare stocks
An ATR of 2.5 is a lot for a stock worth 20 and very little for one worth 1,000. To compare stocks you divide the ATR by the price:
ATR % = ATR / price
ATR % changes over time: it rises when the market is nervous and falls when it is calm. So it is worth comparing a stock not only with others but also with its own history.
What the ATR is used for
1. Placing stops outside the noise. If a stock moves 2% on a normal day, a stop 1% below the purchase price will be hit by chance. Placing the stop at a multiple of the ATR keeps it outside the ordinary range. We explain the different kinds of stop in What a Stop Loss Is and How to Place One.
2. Sizing positions. With the same amount invested, a stock with twice the ATR swings twice as much. Some investors invest less in more volatile stocks so that each position carries a similar risk.
3. Putting moves in context. A 3% drop is an event for a stock with an ATR % of 1% and an ordinary day for one with 4%.
How we use the ATR at InbestPlanners
1. In the stops. Both methods set a volatility stop on the day of entry, at a multiple of the stock's ATR at that moment, with a maximum distance: never further than -10% for Bounce and -15% for Impulse. The stop is fixed when the position opens and does not change afterwards.
2. In the Bounce entry. A Bounce signal looks for a sharp drop measured with a two-session RSI. How sharp it has to be depends on the stock's relative volatility: nervous stocks need a deeper drop and calm stocks a smaller one, so the same rule makes sense across very different companies. We explain it in What Is RSI and How to Use It.
3. To avoid frozen prices. When a stock barely moves for days, for example after a cash takeover offer has fixed its price, a new signal would have levels that mean nothing. In that case no new signal is published.
4. In the model. The relative ATR is one of the measures of volatility that our Conviction Score takes into account. The full list of rules is on the methodology page.
Three common mistakes
1. Reading the ATR as a direction. A rising ATR can come with a strong rise or with a sharp fall.
2. Comparing ATRs in currency across stocks. Always use ATR % to compare companies with different prices.
3. Forgetting that it changes. A stop sized with a calm period's ATR can be too tight when the market gets nervous, and the opposite.
In short
- The true range counts the gaps between sessions; the ATR is its average.
- The ATR measures how much a stock moves, not where it is going.
- ATR % (ATR divided by price) lets you compare stocks.
- It is the natural tool to place stops outside the ordinary noise.
This content is for educational purposes only and does not constitute financial advice. Past performance does not guarantee future results.