Volatility ATR

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Description

The Average True Range (ATR) indicator measures a security's volatility over a given period. As such, the indicator does not provide an indication of price direction or duration, only the degree of price fluctuation.

More specifically, the ATR is the (moving) average of the True Range (TR) for a given period. The TR 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.

Hence, the ATR for some period N is the sum of all the TRs over this period divided by N. Typically, N is taken to be 14 days, but within the Bourse, you can specify the period of your choice.

An assessment of the prevailing market volatility must accompany the deployment of any trading strategy. If market volatility is high, stops will need to be placed further from the market in order to avoid whipsaws (when a market moves so that one is stopped out and then turns in the direction of the original signal). If volatility is low, indicators may generate a number of false signals whilst the market is directionless. Most technical strategies work best in markets of medium volatility.

High volatility is often experienced at the end of a trend, and is said to be an indication the trend is about to reverse. Volatility is also a key component in options pricing. When volatility is high, options become more expensive, and when volatility is low, option premiums become cheaper.

References:

1. Colby and Meyers (1988). The Encyclopedia of Technical Market Indicators. Irwin.

2. Wilder, J. W. (1978). New Concepts in Technical Trading Systems. Trend Research.