One of the first questions a trader should ask about any market is simple: how much does it normally move? A stop-loss that suits a quiet currency pair would be knocked out in minutes on a volatile tech share. Average true range, usually shortened to ATR, is a tool designed to answer that question in a single number.
What average true range measures
ATR was developed by J. Welles Wilder, who also created the relative strength index. It measures volatility, meaning how far price typically travels over a period, without saying anything about direction. A rising ATR means the market is moving more. A falling ATR means it is quietening down.
The calculation starts with the true range for each period. That is the largest of three distances: today’s high minus today’s low, today’s high minus yesterday’s close, and yesterday’s close minus today’s low. Using yesterday’s close captures gaps, such as when a share opens sharply higher or lower after results. ATR is then an average of the true range, most commonly over 14 periods.
Why it matters
ATR gives traders a sense of normal noise. If a share’s 14-day ATR is 5 pence, a move of 3 pence is just a typical wiggle. A move of 15 pence is unusual and may be telling you something. That context helps you judge whether a move is meaningful or just the market breathing.
Using ATR for stops and position size
A popular use is setting stop-losses. Rather than picking an arbitrary distance, some traders place a stop at a multiple of ATR, such as 1.5 or 2 times, away from the entry. That keeps the stop outside the normal daily noise, so it is less likely to be triggered by random movement.
ATR also helps with position sizing. If you decide to risk a fixed amount on each trade, a wider stop on a more volatile market means you should trade a smaller size. That way, a volatile share and a quiet one carry similar risk in money terms, which is exactly what sensible position sizing aims for.
A simple example
Suppose a FTSE 100 share has a 14-day ATR of 20 pence and you buy at 500 pence. Using a stop of two times ATR, you would place it at 460 pence, a 40 pence risk per share. If you are prepared to risk £200 on the trade, you could buy 500 shares. If the ATR were only 10 pence, the stop would be 20 pence away and the same £200 risk would allow 1,000 shares.
Common mistakes
A common mistake is reading ATR as a signal to buy or sell. It says nothing about direction. Another is forgetting that ATR changes. After a big shock, such as a results surprise, it can jump and stay elevated for weeks, so stops based on an old reading may be too tight. A third is comparing ATR across markets without adjusting for price, since a 2-point range means very different things on a £5 share and a £50 one.
The bottom line
Average true range measures how much a market typically moves, including gaps. It does not predict direction, but it is one of the most practical tools for setting sensible stops and sizing positions so risk stays consistent. If you want to check how well your own risk habits stand up, the free Samuel & Co Trading Trader Assessment is a good place to start.
