The key to success in trading is all about maximizing your profits and minimizing risk. The Average True Range Trading strategy will help you to achieve just that. The Average True Range indicator, or the ATR indicator, will help you to reach this goal. Our team at Trading Strategy Guides will show you how to use the ATR indicator to accomplish 2 things:
- How to use the ATR indicator to measure stop loss placement.
- How to use the ATR indicator to measure profit targets.
The Average True Range strategy can be successfully applied to any intraday time frames and bigger time frames. It can also work on different asset classes. The main idea behind the Average True Range Trading strategy is we only want to trade when the market is ready to accelerate. This is the same in our article, Breakout Trading Strategy Used by Professional Traders.
If we identify how much the price moves on average, this can be helpful to achieve consistency in trading. This can be accomplished by using the ATR Indicator.
Before we move forward, we must define the ATR indicator. You'll need this for the Average True Range Trading strategy and how to use it:
ATR Indicator Explained
Simply put, the ATR indicator measures the volatility of price changes of any security or market. In this regard, the ATR is a universal indicator. The indicator works the same with the stock market, commodity market, Forex currency market, and so on.
The ATR indicator measures the volatility in pips. This is a great way to read the market volatility. Simply knowing the volatility of the last day or the last hour, doesn’t provide us with enough data to be able to make an informed decision. This is why the ATR indicator determines and plots the average of a specific numbers of sessions.
By default the ATR indicator is set to 14. So, if you’re on the daily chart, the ATR indicator will show you the average volatility from high to low over the past 14 days. By contrast, if you’re on the 1h chart, the ATR indicator will display the average volatility over the past 14 hours.
The ATR indicator will display the volatility value in the top right hand corner of the ATR indicator window.
The best average true range period to trade with is 10. Our team at Trading Strategy Guides has found out through extensive research that 10 sessions or 10 periods is the perfect number to measure the volatility.
How to Use the ATR indicator
The ATR indicator is an important indicator. When used in the right way, it can grow your profits and decrease your losses. The biggest misconception about the ATR indicator is that traders mistakenly believe a higher ATR value means bullish trend and lower ATR value means bearish trend. This is wrong and far from the truth.
The ATR indicator doesn’t say anything about the trend direction. Read, MACD Trend Following Strategy- Simple to Learn Trading Strategy, to learn more. It is one of the best trend following strategy if you want to learn a strategy to determine the trend direction.
However, to some degree, with the help of the best average true range Forex strategy, we can determine the market trend. This can be done by looking at the general ATR value relative to the trend direction.
In the figure below, we demonstrate how the ATR volatility changes notably during different stages of the trend.
What we can notice is that during uptrends the ATR indicator tends to post lower volatility. During downtrends, the ATR indicator tends to post higher volatility. The reason behind this ATR volatility phenomenon is given by the fear factor.
What do we mean by this?
Well, as the old trading aphorism says, “Market take the stairs up and the elevator down.” It’s the way the market has been functioning for centuries.
Moving forward, we’re going to introduce you to an unconventional way of doing technical analysis. We’re going to apply the 20-day moving average over the ATR indicator. Many platforms will allow you to accomplish this. However, if you are not able to perform this action on your platform, we highly recommend you to sue the free web-based platform TradingView.
How to Overlay Indicators Over another Indicator
Using the TradingView platform, after you have attached the ATR indicator, simply move with the mouse cursor over the ATR indicator window. Right click and select, “Apply Indicator on ATR.” Another window will pop up from where you can select a Moving Average using a 20 period.
Let’s be quite frank here, you’ll not find this kind of stuffs anywhere else. Our team at Trading Strategy Guides has been using an unorthodox approach to trading. This is one of the reasons why we have been extremely successful.
Now, it’s time to show you with a real demonstration how the ATR indicator works. You can get more comfortable incorporating this amazing indicator into your trading strategy.
Average True Range Trading strategy
(Rules for Buy Trade)
Step #1: Make Sure Your Chart Setup Configuration Looks the Same as our Price Chart
The Average True Range Trading strategy has a chart configuration with two windows:
- First window should contain your favorite currency pair;
- The second window should contain the ATR indicator with the 20-EMA attached to it (use the above instructions in order to overlay the 20-EMA).
Now that we have our chart properly configured, it’s time to move to the next step of the best average true range Forex strategy.
Step #2: Wait for ATR Indicator to break above 20-EMA
A breakout in the ATR indicator reading above the 20-EMA is indicative of higher volatility to come. With higher volatility, this also means trading opportunities and bigger profits to be made. A break of the ATR line above the 20-EMA can be a great proof of a new trend.
The Average True Range Trading strategy incorporates not just the ATR volatility readings, but it also looks at the price action to confirm the increase in the ATR volatility. This brings us to the next step of the best average true range Forex strategy.
Step #3: Check the Price Chart to Ensure the ATR Breakout is followed by a Price Breakout
After the ATR line broke above the 20-EMA we want this to be followed by a break in price as well. If we’re looking to buy, we want to see a big bullish candle relative to the previous candles popping up on the chart. If the price breaks up and is accompanied by a break higher in volatility, there is a high probability of the market to move in the same direction.
Now, all we need to establish is how to enter the trade. If we already have an idea of where the market is most likely to move. This brings us to the next step.
Step #4: Enter Long Once we break Above the High of the Breakout Candle
Depending on your preferred time frame, you’ll have to wait until the breakout candle has been developed. Then enter long once the next candle breaks above the high of the breakout candle.
This is key to the success of the Average True Range Trading strategy. You need a big bold candle to confirm the ATR breakout. You’ll learn soon that the ATR indicator will break many times above the 20-EMA. But it won’t be confirmed by the price action in which case you don’t want to execute any trades.
The ATR indicator is a great tool to use when it comes to establishing profit targets. This brings us to the next step of our Average True Range Trading strategy.
Step #5: Your Take Profit Target should be Equal to the ATR indicator value
The ATR indicator can be of great help to determine your take profit target. This is self-explanatory because if you know how much, on average, the market is prone to move, we want to conform to this reality and have that as a target.
In our case, we can see the ATR volatility reading has a value of 16 pips.
This means our profit target should be calculated 16 pips above the high of the breakout candle. The breakout candle high is at 1.1255 and adding 16 pips to that price we end up with a profit target at 1.1271.
It’s not over until you know where to place your protective stop loss. This brings us to the last step of the best average true range Forex strategy.
Step #6: Place the Stop Loss below the Breakout Candle Low
In trading, you have to learn to always protect your back and hide your protective stop loss at the most logical point. A break below the breakout candle low will invalidate our trade idea. This is the place where we want to hide our protective stop loss.
Note** The above was an example of a buy trade. Use the same rules – but with the only difference that you need a bearish breakout candle – for a sell trade. In the figure below, you can see an actual SELL trade example using the best average true range forex strategy.
The Average True Range Trading strategy provides you with an unorthodox approach to trading. It combines both the market volatility and the price action to provide us with the best trades possible. We hope that by now you’re sold out to the power of the ATR indicator’s ability to forecast the market with the high degree of accuracy.
Please don’t forget to check our previous article related to Bitcoin and the cryptocurrency. You don’t want to miss the next big trend in cryptocurrencies. Please read, The Best Bitcoin Trading Strategy – 5 Easy Steps to Profit.
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