Published On: Sun, Feb 10th, 2013

Trading high volatility using Average True Range Indicator

You can utilize this indicator to supply you with an indication about the market’s willingness to support a currency pair by focusing on the daily volatility levels and movements of price. In 1978, the Average True Range (ATR) volatility indicator was present to the financial markets by J. Welles Wilder. He recommended that the ATR operates best when used with the longer-time frames from the hourly upwards together with a period setting of 14.

You will find that the ATR has been designed to record the average of the current scope of price over a specified time-period. In addition, you need to know that this range is determined by using the largest difference between the low and high of the daily price; the distance between the opening and highest values of the daily price and the difference between the lowest and opening values of the daily price. The ATR basically represents the moving average associated with the real price range.

You must realize that high ATR readings suggest that a major price reversal is imminent when accompanied by high volume levels. In contrast, price flat-lining is represented by low volumes. Wilder developed the Average True Range Indicator to indicate that low values equated to those conditions more ideal for range trading whilst high values are indicative of price tops and bottoms.

 true range indicator 1

You can detect many of these features by studying the above diagram. You will notice at the start of the time-frame that the high ATR readings clearly identify a market top. In addition, you can confirm that the very flat price movement just after the middle of the diagram is represented by low ATR readings.

As such, another main concept behind the design of the ATR is that lower figures suggest that the strength of the current trend is weak whilst high values predict that possible trend breakouts are imminent. In addition, you should realize that high ATR readings normally happen after panic selling or buying have attained such levels that they are capable of producing price bottoms or tops. In contrast, low ATR readings are associated with range-trading.

When he developed his ATR, Wilder refrained from deploying his normal design procedures. As such, the ATR does not include oversold or overbought factors into its primary equations. You should also be aware that the ATR was not specifically developed to generate signals recommending new trading opportunities. Instead, the main strength of the ATR is that it is very good at predicting when market tops or bottoms are forming by displaying very high values. As such, you should consider that high ATR readings may well be advising you that a price reversal is imminent.

As Wilder developed the ATR to primarily cope with excessive volatility, you should seek to increase your profitability during such times by integrating the ATR into your trading strategies. Your prime objective when you trade during times of high volatility is to defend yourself from financial losses.

Although every type of investment involves a degree of risk, you should always consider gold trading to be especially risky because it can generate excessive levels of volatility that are much greater than those of other assets. This means that unless you introduce money management controls, you could incur substantial losses that could even obliterate your entire account. Gold trading can produce levels of volatility that can generate rapidly moving and unpredictable price patterns as shown on the next chart.

true range indicator image 2

The above diagram vividly demonstrates why you must exert so much caution when trading gold. Specifically, you should carefully note the sheer size of the fluctuating trends. First a bull trend is created consisting of over 7,000 pips followed next by a bear trend of over 4,000 pips. Finally, another bull tread is formed comprising over 5,300 pips. Such large swings of thousands of pips do produce significant profit potential but only if you can control your risk exposures.

You can achieve this objective by devising a trading strategy that incorporates the ATR as it has been specifically design to cope with such levels of volatility. You will then increase your ability to detect opportunities to capture the large profits presented while still minimizing your risk levels.

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About the Author

- Marcus Holland has been trading the financial markets since 2007 with a particular focus on soft commodities. He graduated in 2004 from the University of Plymouth with a BA (Hons) in Business and Finance.