One of the more popular indicators, the Average True Range technical analysis indicator is used to measure the volatility of an asset traded on the markets. The ATR indicator was developed by J. Welles Wilder, the same analyst who developed the Relative Strength Index. Let’s see how crypto traders use the ATR to their advantage trading cryptocurrencies.
The basics of the ATR indicator
In order to understand how the ATR works, it helps if you know some of the math behind it. To create the ATR, you would first identify the True Range of the period on that particular crypto chart – simply subtracting the lowest price from the highest. Once you have the True Range, you would then calculate the average value for the period on the crypto chart by using the Exponential Moving Average on the values.
In general, the ATR is calculated from the 14-day moving average of a series of true range indicators. The longer the moving average period is used, the less trading signals are generated.
Now that you understand the formula of the ATR indicator, let’s see how you generate trading signals for crypto.
Crypto trading signals created with the ATR
As outlined above, the basic function of the ATR is to measure volatility of the particular financial instrument. In the crypto chart below, we see a BTC price chart where the ATR suddenly bursts higher. You will see that this sudden increase in volatility overlaps with Bitcoin moving higher on the 4h chart.
The highlighted purple box shows the exact overlap. The next phase, which comes after the move higher is finished, shows a consolidation of Bitcoin. The BTC price action trades sideways with a slight bias to the downside. This trajectory is reflected by the ATR indicator, which decreases as the sideway action almost always comes with the lower volatility.
Signals are generated whenever the price action surpasses, or closes below, an average ATR value for that day, the ATR reading increases/decreases. In this case, ATR issues a signal as it shows that the trend is prevailing in one direction and may continue higher or lower.
For instance, if you look at the chart above using Japanese candlesticks patterns, you see that Bitcoin created a series of long candles which easily surpass the value of the ATR. So, the indicator is sending the trading signal that a trend may be starting as the volatility is picking up.
Therefore, the ATR should be mainly used to identify trading ranges and pinpoint the limit of up or down moves. When the ATR values are lower, it means that the volatility is lower and your stop loss may be a bit tighter than usual as the asset currently trades in a quiet market.
The same applies for profit-taking levels. For instance, when traders say “2 ATR stop”, it practically means that the distance of their stop, compared to the entry, is two times the size of the calculated ATR.
Always use more than one crypto trading indicator
Keep in mind that the ATR measures only the volatility. For this reason, the ATR may generate mixed signals, which may support or not support the prevailing trend. The increase in volatility may mean two things: 1) a trend is starting to form or 2) a reverse is about to take place.