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Average True Range (ATR) is an indicator of technical analysis measuring volatility of a financial instrument. Originally, Average True Range was purposed for trading with commodity futures.
Average True Range indicator is not dedicated to forecasting direction of asset's movement and moreover does not have a goal to make any kind of forecasting. Average True Range is only meant to describe volatility (present variability) of instrument (asset) and is developed as a supplementary indicator of technical analysis, which must be combined with other indicators. In other words, Average True Range assists in analysis of one or another asset.
It is important to remember that calculations and measurement regarding this indicator are based on absolute figures and indicator's values will vary depending on cost of analyzed financial contract. In simpler words, the indicator will show one figures for asset costing $1 and other figures for an asset costing $3.
On a long-term chart the indicator may start sending false signals if cost of instrument significantly changes within a definite period of time. In this regard, this indicator can only serve purposes of comparison within the range one of instrument and only on condition that price of present asses did not go through strong fluctuations.
Average True Range indicator can hardly be applied in technical analysis like for example Stochastic and other often used tools are applied, but since ATR is applied in other overlaps and indicators, it is impossible to do without it.
Such notion as Average True Range is applied in several technical indicators.
True Range is the highest of three following differences:
- High – Low
- High — Closeprev
- Closeprev - Low
Application of Average True Range
ATR must certainly be used exceptionally for the instruments with high volatility, that is to say, all those which are rather variable. It is important to remember that Average True Range is not a forecasting tool, but it is a tool for describing present situation (volatility). Therefore, this indicator shall only be used as a supplementary tool.
Conclusion
The indicator only shows volatility level. It does not allow making any kind of forecast and just describes market conditions. It only can be applied as supplementary to other indicators. But it should be remembered that since ART composes measurement for some other tools, you should learn it too.
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