Average true range (ATR) is a volatility indicator originally developed by J. Welles Wilder. The indicator describes the degree of price volatility. The higher the ATR, the more volatile a stock is.
We often hear traders talk about ATR, but how do we use it? Well, today I will share with you how I use ATR for day trading.
Below is a study I did on SPY with a 10-days ATR. You can use a 14-period or 20-period ATR, it won’t make a big difference. The data is on SPY from January 2000 to February 2022. In this study, I used the previous day’s ATR to compare it against the intraday range. This is because going into the day, we only know the previous day’s ATR. Here is the breakdown of the % of days when the intraday range is less than or equal the daily’s 10 period ATR.
As you can see from the figure above, 66% of the days have a range that is less than 1 ATR. Nearly 82% of the days have a range that is within 1.2 ATR! At 1.4 ATR, that captures more than 90% of the days!! In other words, daily ATR can be a very helpful tool for us to determine the high/low of the day.
So, how do we use daily ATR for day trading? For example, if you see that the S&P 500 has been selling off all morning. It is trading at the low of the day and its intraday range is currently 1.2 ATR at 12 PM. Knowing that nearly 82% of the days have a range of less than 1.2 ATR, and only 18% of days have a range of more than 1.2 ATR; It’s probably a good spot to be thinking about buying. There is still a lot of time left for the day, so more often than not there might be at least some kind of pullbacks from the S&P 500.
To summarize, ATR can be a very effective indicator to use for day trading. By itself, it is not nearly enough to take a trade. However, if you combine ATR with technical analysis and other edges, it can boost your results tremendously.
Disclaimer: I am not a financial advisor. All information in this blog is for educational purposes only.
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I found a good use for ATR for something I believe a lot of traders don’t bother too much: I use it to measure the spread. For my trading style and my broker sometimes the spread is pretty high and hence a problem. I’m not a very performant trader so I really need to keep the costs under control to stay profitable. To measure the spread in pips doesn’t make too much sense, 10 pips is almost nothing in daily timeframe but can be very significant on smaller moves.
Long story short I wrote a simple indicator which expresses the current spread compared with the ATR for the current timeframe. Something which looks like 1, 0.5 or 2.1
So if I see that the spread is 1 ATR I know it is a little bit too high for me. Anything less than 1 ATR might be palatable. 🙂 It helps me to filter out possible trades where the costs are too high.
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Wow! That’s a really good way to use ATR especially if someone is day trading multiple stocks. I noticed that even the popular stocks can have ridiculous spreads during lunch time, so an indicator like this would be very helpful. You should write a post on your Twitter about how you come up with this indicator!
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