Module 6B: Indicators · Lesson 5 of 10 · Back to course
If you only learn one indicator properly, ATR is a strong candidate. It doesn’t tell you which way to trade, and it doesn’t claim to. It tells you something more useful for staying in the game: how much the market normally moves. That makes it a risk-management tool, and risk management is what most beginners get wrong.
What it is
Average True Range was introduced by J. Welles Wilder in 1978 (the same book as RSI). It measures volatility – the typical size of a candle’s range – over a set number of periods, usually 14. It’s shown in a separate panel, in the market’s own units: pips for forex, points for indices.
ATR has no direction. A rising ATR means candles are getting bigger, whether price is rising or falling.
How it’s calculated (in plain English)
Step 1: True range for each candle. The “true range” is the largest of these three:
- Today’s high minus today’s low
- Today’s high minus yesterday’s close (ignoring minus signs)
- Today’s low minus yesterday’s close (ignoring minus signs)
Why not just high minus low? Because of gaps. If the FTSE 100 closed at 7,950 on Friday and opened at 8,000 on Monday after weekend news, Monday’s high-to-low range might be small, but the market really moved much more than that. The true range captures the gap.
Step 2: Average it. ATR is a smoothed average of the true ranges over the last 14 candles (Wilder’s smoothing, so each new candle nudges the average rather than replacing a whole value).
How traders use it
1. Setting stops outside normal noise. A stop that’s smaller than the market’s typical candle is likely to be hit by ordinary movement. Many traders place stops at a multiple of ATR – often somewhere around 1 to 2 × ATR – beyond their entry or beyond a nearby level. The multiple is a personal choice to be tested, not a rule.
2. Position sizing. Once you know your stop distance, you size the position so that being stopped out loses only your chosen risk (for example 1% of the account). A wider ATR-based stop means a smaller position, so your money at risk stays the same. This is the core idea of Module 8.
3. Recognising unusual conditions. If today’s ATR is twice its usual level, the market is unusually volatile – often around big news. Some traders reduce size or stand aside.
4. Realistic targets. If the daily ATR on GBP/USD is around 80 pips, a target of 200 pips by the end of the day is asking for an unusual day.
5. Trailing stops. Some traders trail a stop a fixed multiple of ATR behind price. The Keltner Channels lesson shows ATR used to build bands.
Common mistakes
- Reading ATR as a direction signal. Rising ATR in a falling market is still rising ATR.
- Using ATR from the wrong timeframe. If you’re trading on a 15-minute chart, a daily ATR stop will be far too wide; a 1-minute ATR far too tight. Match the ATR to your trading timeframe.
- Keeping the same position size when ATR doubles. A stop twice as wide with the same stake means twice the money at risk.
- Thinking an ATR stop can’t be hit. It just sits outside typical noise. Unusual moves happen, and stops can be filled at a worse price in fast markets or over gaps (see Lesson 1.3).
- Comparing ATR across markets. 40 points on an index and 40 pips on a currency pair aren’t the same amount of risk.
Example (illustrative numbers)
All figures are made up for teaching purposes. They aren’t real prices or a trade idea.
Part 1 – true range with a gap. On the FTSE 100 daily chart:
| Yesterday’s close | Today’s high | Today’s low | High − low | High vs prev close | Low vs prev close | True range | |
|---|---|---|---|---|---|---|---|
| Normal day | 7,980 | 8,010 | 7,970 | 40 | 30 | 10 | 40 |
| Gap day | 7,950 | 8,010 | 7,990 | 20 | 60 | 40 | 60 |
On the gap day, high-minus-low is only 20 points, but the true range is 60 because of the gap from yesterday’s close.
Part 2 – sizing a demo spread bet. Suppose:
- Demo account: £10,000
- Risk per trade in your plan: 1% = £100
- ATR(14) on the 1-hour chart: 40 points
- Your plan uses a stop of 1.5 × ATR = 60 points
Stake per point = £100 ÷ 60 points ≈ £1.66. Rounding down to your provider’s nearest allowed stake (say £1.60 per point) keeps your risk at about £96.
Now suppose a week later ATR has risen to 80 points. The same rules give a 120-point stop and a stake of £100 ÷ 120 ≈ £0.83 per point. The money at risk hasn’t changed; the position has halved to match the bigger swings. Before placing a real trade you’d also check the spread, the minimum stake and the margin your provider requires.
The prop firm angle
This is where ATR earns its place. Most challenges have a daily loss limit and a maximum overall drawdown. If you size positions without reference to volatility, a normal-for-today swing can wipe out a big slice of the day’s allowance.
Simple ways traders use ATR in a challenge (on demo first):
- Size every trade from an ATR-based stop so each loss is a fixed, small fraction of the account.
- Check how many average losing trades would hit the daily limit. If it’s two or three, risk per trade is probably too high for comfort.
- Reduce size or stop for the day when ATR spikes around big news – and check whether the firm restricts news trading at all (Module 15).
Our True Cost Calculator shows what repeated failed attempts cost in fees. Volatility-based sizing is one of the simplest ways to avoid failing on a single bad day.
Key takeaways
- ATR measures how much a market typically moves per candle, including gaps. It has no direction.
- Use the ATR from the timeframe you trade.
- Wider ATR-based stop → smaller position, so the money at risk stays the same.
- An ATR stop sits outside typical noise; it can still be hit, and fills can be worse than planned.
Quick quiz
- What three values does true range compare? (High minus low, the gap between the high and the previous close, and the gap between the low and the previous close – ignoring minus signs.)
- Yesterday’s close was 1.2700; today’s high is 1.2760 and low 1.2740. What is the true range? (60 pips – the gap from yesterday’s close to today’s high.)
- If ATR rises, does that mean price is rising? (No – it means candles are getting bigger, in either direction.)
- With £50 risk and a 25-point stop, what stake per point keeps risk at £50? (£2 per point.)
- Why might a stop smaller than one ATR be a problem? (It’s inside normal movement, so ordinary noise is likely to hit it.)
Key terms
ATR · True range · Volatility · Gap · Position sizing · Stake per point · Daily loss limit · Also see Trading jargon in plain English.
Try this
On your demo platform, add ATR(14) to the 1-hour chart of the market you practise on. Every day for a week, write down the ATR at 8am UK time. Then, using a pretend £10,000 account and 1% risk, work out the stake per point for a 1.5 × ATR stop each day. Notice how much the “right” size changes from day to day.
FAQ
What’s a good ATR multiple for stops? There’s no universal answer. Common choices are between 1 and 2 × ATR, but you should test whatever multiple you use on historical data and on demo.
Does ATR work for spread betting? Yes – it’s calculated from price, so it works for any market. In spread betting you convert the stop distance into a stake per point.
Is ATR the same as the daily range? Close, but not identical. ATR averages true ranges, which include gaps from the previous close.
Disclaimer: This page is general education, not financial or investment advice or a personal recommendation, and it doesn’t take your circumstances into account. Examples are hypothetical, for illustration only, and not an invitation to buy or sell. Learning a strategy doesn’t guarantee profits. Past performance is not a reliable guide to future results. Futures, spread bets and CFDs are complex and carry a high risk of losing money quickly because of leverage, and most retail traders lose money. With a real futures account, losses can exceed your deposit. Only trade with money you can afford to lose, and speak to an independent FCA-authorised adviser if you’re unsure. Read our full risk warning.