Using the Average True Range | Supplementary Material

Alright guys, what's going on? This is Ryan, AKA Kenron Clark with blockroots. And in this roadmap video we're going to be talking about trading with the ATR or the average true range. So what is the atr? Okay, the ATR is something that is commonly used in traditional markets. It's not really referenced often enough with crypto. It is a volatility indicator. So it shows us what the change in volatility is over time. Okay? And since it's a volatility indicator and a lot of it has to do with the range of price movement, it can help us identify what falls within norms and what falls outside of norms. So the same way that we'll talk about trying to identify what is a move that is outside the current standard deviation of price movements, the ATR is an indicator that when expressed in multiples, can help us identify what falls outside of what is considered par for the course. Okay, so it's a volatility indicator, all right? It is going to take the current volatility over, you know, such and such period of time. All right? So it'll be based on a certain period setting, the same way that a moving average will be. All right. It is not a momentum indicator, it is not a trend indicator, it is just a volatility indicator. Okay? But it is very useful. All right, so the calculation or the formula for it for the Wilder's ATR is the prior average true range multiplied by 13 plus the current true range divided by 14. So it's an average true range. So you have to be wondering what is the true range? Okay, now the true range is defined as the greatest value from one of the following. Okay, so either the current high minus the previous close. So the current high minus the previous close. Alright, the current high minus the current low. Okay, so this entire range right here or the current low minus the previous close. Okay, so whichever the case out of these is the largest value, that value is going to be used in the calculation for the true range. Alright, so normally as far as a generic setting go, this is going to be a 14 period. So if you just pull it up on trading view, it's probably going to be either 12 or 14 period ATR. And again this is something that you can change to represent, you know, maybe more recent information or you could have it as a, you know, a longer, more smooth out version based on, you know, a further back sample of, of periods. Okay. Or rotations. And when I say rotation, I'm not talking about the rotation that we normally Talk about in auction market theory, I just mean a single candle, meaning a rotation in time.

We'll call this average true range and often it'll be used on the daily. But you can see what this read is based on any time frame. So we could look at the average true range for the four hour chart. We can look at the average true range for the five minute chart. Really it's going to be the same way the moving average will be in that what time frame you have open. It's going to be calculating based on that period setting. Okay, so how do we use the atr? Okay, and again this is something that is very useful for multiple reasons. Alright? So there's three things that we can do with ATR right off the bat. Okay? We could use it to place volatility stops, all right? We can use it to identify conditions pre breakout and we can use it for mean reversion trading. Okay? We could also use it for along the lines of mean reversion trading. We could use it to identify potential exhaustion, all right, either to the upside or downside. So for volatility stops, okay, we can set a stop based on the multiple or a multiple of the current ATR. Okay? So if we see that the current ATR for the last 14 days has been $200, well that means that any movement of $200 or less is considered par for the course. It's considered a market norm. So if we have any fluctuation that falls within that value, then it's just normal price behavior. The same way that if you were to.

Enclose price in a range and you'd say anything within that range is considered norms for that range. Or the same way that if we look at the market and we take a value area and we say within that value area is market norms, so that's fair value. Anything under the current ATR is going to be considered just normal behavior for that period, especially if it's on the daily. So if we are setting a stop and we're in a trending market, or we're setting a stop just based on market structure. Let's say the current ATR is $200. Well, if the stop we're setting is $200 and below, then there is no reason to think that we might be stopped out of a trade just through normal price behavior alone. Okay? So taking the ATR into account is going to be something that is very useful. And this is, this is the premise behind a volatility stop. So we take either a multiple of 1.5 or 2 or 3, we take the current ATR and if we're trading on a daily time frame and we multiply the ATR by that value. So standard would be somewhere along the lines of 1.5 to 2. Obviously, the larger the multiple you use, the more of a window of space you're going to give price to move. But when you're position sizing properly, this is going to mean that you're going to be risking less because you're going to have to incorporate that larger stop. This is really good for trend following and this is really good for setting stops beyond the extremes within market structure to make sure that we're not just going to get stop hunted. Okay. So a lot of times traders will just set their stop below the last low. Okay. Or above the last high if they're, you know, longing or shorting based on market structure. And instead, what you can do is you can take the current ATR and you could incorporate that into the distance from that lower, from that high. So we'll show you how to do this. Okay. It can also help us identify breakout conditions. So since it is a measure of volatility, we could identify when volatility is compressing. So say we are coming off of being in a trending market, all right, The ATR is probably going to be pretty high, right? It's going to taper off though, as price begins to compress. If you think about going from a trending period where you have these really large expansive cases, candles expansive, meaning the range is large. So just from that alone, you can imagine that the ATR is going to be affected since it incorporates the range of price behavior. So when the market starts to settle in, consolidate, the ATR is going to drop off. We're going to see with the ATR indicator that there's a compression in this range. And what you'll find is right before major breakout periods, the ATR will be at lows. So if you could look at current assets, historical atr, what you'll see is that likely before major breakout periods, the ATR was at or around previous historical lows. So it's the same thing as the concept of volatility expansion. So in markets, you go from periods of low volatility to high volatility back to low volatility. So this is sort of the ebb and flow of markets, right? So you go from, you know, compression to boom to bust, back to compression. All right? It's this constant period of contraction and compression leading to expansion, going back to compression, contraction. So when we see that the ATR is a really low value. If we have some type of directional bias, okay, this will help us maybe time or position ourselves pre expansion. Okay, so, so we could also use this for mean reversion trading. Okay, so if we see that the current ATR is for the last 14 periods or for the last seven periods is, you know, $150, okay? If we have a move really that there's no basis for the move, there's no current trend, we're in a ranging environment, price is pretty choppy. If we have a move that let's say is two times the current atr, we recognize that it's maybe on unsubstantial or insubstantial volume. There's no real reason to assume that it is anything that is to be deemed as a potential breakout. So it's just volatility and noise. There's no reason to associate meaning with it. We could use the ATR multiple, in this case two times the current ATR to identify what things are maybe outside of market norms and potentially will mean revert. So again, the same way that when the market is really extended to the upside or to the downside, typically you'll get some type of kickback. Okay? So when prices are really extended upward and they go parabolic, we could expect a correction. When prices are really extended to the downside, we can expect a rally at some point. So the markets don't just go straight up and they don't just go straight down. So what you'll do is you'll take the current ATR and if you have a move, you set some type of benchmark, maybe it's know, 2 or 2.5 or even 3. And you could take your chart, put those areas on the chart and say, okay, well, if we come within this area, then this is an area that I'm looking to sell, right? Therefore I'm looking to fade. Or if we are again in a period where it's compressing long enough, then maybe this is the beginning of a trend. So this might be the beginning of a trend, in which case we wouldn't want a mean revert trade at that point because at that point we'd be essentially selling the beginning of a new trend, or in this case, selling the beginning of a new trend upward or buying a new trend that is moving downward. So again, it helps us mean revert trade though, because when we identify what market norms are, when something falls outside of the norm, okay, there are many times where it will be the case where the Market will continue in that direction. But more often than not, especially when we take certain contexts into consideration, such as a market having been ranging for a long period of time, it's not really near any edges. So we're not really near the high or the low. We're just having more of this kind of spurdy noisy behavior. Well, if you get a move that is outside of norms, it might be worth fading or taking a mean version trade based upon. So let's take a look at a few of these examples on the charts. All right guys, so here we're looking at a daily chart of bitcoin. And this is the ATR indicator. Down here you just go to indicators, search for the standard atr. Alright, There are probably some customized ones that offer signals and strategies built around or incorporating ATR. But just go with the standard one. Again, the standard setting is a 14 period. So we're on the daily now. So it's taking 14 daily bars to compute this. If we change it to the four hour, it's not the daily anymore. It's taking 14 four hour candles. And again this is similar to moving average in that you could change similar to really any indicator in that you could change the period setting. So with the atr, if I change it now to a lower value, it's going to become a bit more sensitive, all right. It's going to become a bit more sharp, it's going to reflect more recent values. If I put it on a higher time frame value or a longer period, it's going to be more smoothed out. So what I would say is keep it at around 14. So anywhere from 10 to 14. So what this is showing us is that the average true range currently is $326. Okay, so $326 and pretty much anything below that value. And you can see from the beginning of this trend from low to high has been from around $260 to $360. So anything within that range is pretty much considered par for the course. All right, it's considered normal. So it's a market norm if it's within that value. So one of the first things that we can do with the ATR is place a volatility stop. So if we're looking at this right now, we're considering, all right, maybe this is currently the beginning of a new trend. We want to enter in this trend at a pullback. Well, where can I place my stop? Some people might say, well I'm going to place my stop below the last wick. Some people might Say, well, I'm going to place my stop below this last low. And in a really choppy market, especially like bitcoin, all right, you'll see that there are many times when the market moves up violently before even continuing upward with the trend. The ATR allows us to incorporate market norms to compute a stop that again incorporates market norms or volatility. Consider the ATR as a measure of volatility. It shows us what is normal for what period we're looking at. Really, if we place a stop that is under at this point, let's say $360.

Then we could very well be placing a stop that is way too close because it is again what is considered par for the course for this period. So from period low to high. And you could see the last time we were above that value was over here and that was at this sell off right here. And preceding that was a low in volatility or a low in atr. And again, that's the next point we're going to get to, which is identifying breakout or expansion conditions. What we would do in this case if we were looking to enter into a volatile trend is we would take a multiple of this value. So in this case, let's say that for this trend it's been anywhere from 260 to $360. So our stop in this case should be at least $360 if we are going to be taking the volatility into account. Right, if we're taking it in properly. So what this means is we'll take the current price, we'll take maybe the most recent high in atr and our stop will be a minimum of that value. So for $360, okay, so from here our stop would be at least 200 and it would be at least at 8,240, because at least in that case we're incorporating the high of the atr. So we're giving price a room to breathe based on what the volatility is for the trend, not just based on some type of structure because there's many times where again the market zigs and zags violently before continuing upward. Right. And the last thing that we want to do is be stopped out because we have too tight of a stop for the market to continue upward in our favor. So one of the better things that we can do is take a multiple of this value. So a lot of traders in a really loose trend like back here, they'll take a high multiple. So anywhere from two to three times the current ATR and you'll actually see that the volatility stop indicator stop. So if we go here, volatility stop, this stop that we're looking at, and I'll make it a little bit easier to see by putting it as a line. This stop that we're looking at is actually a multiple of the current ATR. So it's the 20 period ATR in this case because it's the 20 period length and then it's a multiple of two. So it takes in the 20 period ATR, it multiplies it by two and, and that is the stop distance that is created that actually informs or rather creates this line. So in this case, if we were going to be trying to do that right now, we would have this set to 20. We would take two times the value of the 20 period. Which again, if you want to just see how this works, if we set this to 20 so 20 period, we'll see that now it's at around 350. So the stop is in this case about $700 away from this high. Okay, so the volatility stop, it incorporates that, it incorporates the ATR. So let's take this back to 14.

Okay, so volatility stop is really useful in strong trends or violent trends. So we take the current ATR, we do a multiple of at least 1.1. Right. So you at least want to be the recent high in atr. All right, so we don't want to have the low in ATR because at that point we've expanded upward. So this is really good for following trends. And then again, not just using a market structure based stop that doesn't incorporate any volatility into account. Bitcoin is a very volatile asset. Volatility should absolutely be taken into account. Alright. Another thing we could do is identify where there are those periods where volatility is really compressing. So if you watch the roadmap video on volatility compression, you'll know that we go from periods in the market where there's contraction and compression volatility to expansion. Alright? This is the direction of the market. It goes from compression, contraction, expansion back to compression, contraction, expansion. So it is essentially the flow of energy the same way it works in physics. Right? From potential energy to kinetic energy, back to potential energy. So what we can do is look at the atr. Okay, we could identify where there are historic lows. So you could see in price action where we're compressing, right? So if we're looking at this period right here, pretty obvious precedent price action right here. All right, right here, all these are really obvious. All right. We could see that price was funneling at these points. The daily, individual, daily candles of these areas. We know just from the areas that preceded it, we're really becoming tighter and tighter. And again, the ATR is going to indicate something like that right away. Okay. Because it's just the average of the true range of price behavior. So. So what the ATR indicator allows us to do is it allows us to see those low points. So what you'll see is that at a historic low in the ATR, right around $100, okay. Which is a very low ATR for Bitcoin, especially at these highs, when Bitcoin is $6,421, this is a historic low. So when you see that ATR is really beginning to drop off, especially getting into three digits, that's potential time to maybe set yourself up for some type of breakout trade. All right. Whether or not you're going to. You could even use something like an options play, like a strangle or a straddle. You could have a trigger setup that is using market in for shorts and longs. Okay. So you could collar price with a short and a long market order on the futures exchange. So you could identify these periods though where price action is really compressing, where volatility is dropping off, and assume that again that path occurs where you go from compression volatility to expansion. So you can see again at this low back here, again over here. Low in ATR led to the expansion. And it's not that this is the ATR leading to anything, but it is a visual representation of the overall volatility. And volatility usually compresses really low before it expands. So you see that in price action. You see that in atr. If you use any other volatility based indicators, you'd see that as well. So what you can see is the market will sort of respect these norms as far as the low goes for the recent trend, as far as historic lows go as well. So if we just look at this area over here. So for this period, what we're looking at is right here, this low, which is right up here, this point where we were standing right before this drop off. And then we have right over here, so right here initially first, okay, right here before we had this move up and then again up here, the ATR is going to obviously be really low at this point and stay low. It's not going to change because it's on the 14 day period. So it's not like it's going to immediately change. And that was the one period where it was low. And you know, it was perfect because what happened was price expanded upward and then it expanded downward. But you can see again, the ATR is still very low. All right, because again, this is just four bars essentially. But the overall idea is that low atr, okay, this whole area led to an expansive movement because what it incorporated was all of this, which is arranging price behavior. So anytime price is in a really tight range, the ATR is going to be dropping off. Okay? And then again right over here, all right, which is this low. So there was this shelf over here. And if we just zoom in to take a look at that, what you'll see is that that was this ledge right here. And you can see that when the market is trending down and compressing, sort of like we have these wide candles up here and then it's compressing to a point.

You'Ll see that the ATR was decreasing. So if you just look at ATR and look at the trend, you'll notice that it more or less follows a trend, right? Volatility expansion. So you have a compression in volatility during the bear market. So volatility is decreasing. And then with a bull market volatility, volatility is expanding. So just look at the expansion within this cone. So if you're looking at atr, what you can do is again have that edge in identifying where those areas are. Okay. And if we've been respecting them previously within the trend, maybe historic lows or more recent lows with regards to the last few months, we could be gearing up for again, a point where we're setting up for some type of expansive move. And you can use something like, again, you can use an options play. You could collar price with.

Stop market orders to buy and sell. And maybe you could even incorporate a certain amount of distance around that based on the ATR to have that breakout trade taken advantage of whether it moves to the upside or the downside. But what you're looking at is periods where it's very low and it leads to an expansion. So in this case, again right here you have this low in volatility. And again, that's right over here before we have this expansion upward. And for this entire range, alright? So for this range right here, you'll see that the ATR was compressing. All right, so the ATR following the trend, a large move here, okay? With each of this, see, it's going from lower, high, lower, high, lower, high. Okay? While the lows stay relatively the same. So just think of it about this as energy tapering off. So a big boom, a smaller boom and then an even smaller boom, sort of like ripples. All right, so just I don't want you to think all energy and woo and physics and you know, metaphysical by any means. But, but the point is this, this follows volatility. So when it's really low, it could be potentially gearing up for again an expansion, expansion in either direction. And hopefully we'll have some other tools that we can use to substantiate a claim for one bias or the other, whether it's for the long side or the short side. But what you can see is potentially where a trend changes as well. So when we have a period where volatility is compressing, compressing, compressing, and then you put in something like this over here, a high, we could clearly see that with this high and then the break above that high, we're definitely in a new trend. So we're going from periods of compression, compression, compression, and then clearly to expansion as we break the previous high in volatility. So this movement is considered outside of the norms. We hadn't seen that prior to all the way back here, this high in atr. So if you think about the atr, you can think about it in a way, such as the way that you think about standard deviation. Alright? So when you have a move that is multiples in terms of standard deviation, that may be a potential sign that you should start paying attention. Because if you think about standard deviation, it is identifying what the norms are, right? So what falls within the norms, as far as averages go, what is worth paying attention to that is outside of that norm, what is maybe worth ignoring that's within those norms. So when you see that the ATR is multiples higher than a previous historic atr, maybe this is a substantiation of the claim that maybe the trend is changing and we have an expansion of volatility that is not just noise and is again something that is meaningful. So look at historic lows, look at lows with reference to the current trend. And when we approach those lows, we might be gearing up for again some type of expansion within that trend, or at least.

Some type of short term or intermediate term explosive movement. So the last thing that we could do is identify maybe potential areas where we could take mean reversion based trades. Okay? So with using ATR for mean reversion, remember that ATR more or less represents current market norms. So for this Period right here, you know, we're looking at a 14 period ATR. So we know that, you know, the average true range is right around, you know, sometimes it's 300, sometimes it's 342. In the beginning it was right around, let's say 277 down to 267. The average for this is right around $300. So any movement on the higher time frame over the course of a day, two days within $300 is pretty much considered normal. Right. So how we use the ATR then is we express the ATR in multiples. So if we're trading on the one hour, on the four hour, on the 30 minute, alright, what we can do is keep in mind what the higher time frame ATR is. So let's go back to, you know, earlier within the trend, you see all of these large movements upwards. So move up, move up, move up. Okay. Move up. Right, large move up. Okay. Keep in mind certain market structure though because some of these moves up again are going to be through areas where, you know, clear areas are breakouts and you're not going to get much reversion because you have a lot of eyes waiting for these areas to break. Then there's a lot of follow through. But more often than not what you'll find is if we consider what the current ATR is. So the average ATR for the period is right around 300. If we see any of these moves that are anywhere from 1.5 to 2 times the ATR. So on a lower time frame, so for example, this move right here, this is one hour, two hour, three hour, four hours. In four hours we've traveled from right around 75, 30 all the way up to 8,000. Okay, so this is over the ATR. So this is over what at the time was probably around 270, 290. This is more than 1.5 times that value. So what we'd expect is since that value is normal for the course of, you know, in that case a few days, that any move within a short amount of time that covers that range is likely going to mean revert to some degree. So while this may be the range over the course of a day, this might be the daily range, let's say from 81.63 to 8651. So in this case right around $400 would be the ATR. It's normal for price to do this. It's normal for Price to go back and forth. So on the lower time frames, if you get A move that violently comes up into this area. There's a case to be made for when you're moving within a ranging market to be fading these moves that again are measured in terms of multiples of their current atr. So if we're looking at current price right now, right around 8633, one ATR to the downside, it's going to be right around, right around here. Right around, right around one to the upside is going to be right around here. And then 1.5 is going to be, or rather 2 would be right around here. So 1.5 is going to be right there. Okay. 2 in this case is going to be right around here. I'm not doing the Math exactly, but 1.5 would be right there. So if on the lower time frames we get a violent move into 1.5 times the current ATR, right to the downside, or we get a really impulsive move up, what I would expect is if this occurs over the course of a few hours, I would likely be fading these moves in the anticipation that there's some type of pullback. Right. So there's some type of mean reversion price is going to spend time moving sideways before instead just going straight up or straight down. So using the ATR in this regard is really helpful. You'll find out the current day ATR and what you can do is find out the current day ATR. So in this case, right around $300 for this period. Right. For the current trend. Right. So not just for, you know, not just, just finding the ATR right here, what you want to do is you're looking at the leg of this trend and you're finding out what is normal for this trend. Okay? So the average over that trend. So from the beginning, again, you're right around 248 up until the high is right around 368, 366. So right in the middle is right around 300. So on the lower time frame, if you get a move that is 1.5 times 300 or even 2 times 300, these are all trades you could potentially take the other side of with the anticipation that there'll be some type of correction on that lower time frame move that incurs impulsively either to the upside or to the downside. Another way that the ATR can be used when thinking about it in terms of multiples is for finding those exhaustion periods at tops. So what you'll see is that more often than not, and this is one of the rules of thumb, Is that if we have a move that is two times the current or the previous consolidation period's atr, that that is likely going to represent the turning point for the current move. So what you'll see is that this consolidation period right here, okay, the ATR was right around $200, $170. It starts off right around 164, gets up to about 228. So around 190, 200. Okay, the next leg up, all right, the ATR is just over double that. So The ATR hits around 510, 554. So this is more than two times the previous ATR. So the argument is that this represents when you're two times the previous ATR, the exhaustive period before there's a major consolidation or pullback.

One thing that indicates tops is again, not only if you have, if you're trying to identify where a top is, and let's say we're currently thinking about getting in a trend right here on the presumption maybe this continuation, we see that clearly this is a double top. And we could also look at this ATR and see, okay, this ATR is over 1,000. The previous ATR of this top and even this low is around 400 to 500. This ATR up here is over two times the previous ATR. So now we have more sign than just one that maybe this is exhaustive where you get that last volatility spike to the upside before maybe the market pulls back or maybe the market at least moves sideways. So you'll see that tops and bottoms work this way. So capitulations to the upside, capitulations to the downside will be marked by an increase in ATR by multiples. So from here you can see that from the top here, from around $100 to the bottom, okay, the bottom right around here, three times ATR. Right around here, three times, right around 3.5 times ATR. There's a good case to be made for the market potentially settling in when it is, or rather has increased in ATR after moving sideways, right around 100 and is now over $300. Okay, in terms of ATR. So again, it's expressed in multiples because we're looking at atr, it's an average, right? So anything that's a multiple of that is considered something that is outside of the normal standard deviation of behavior. And a lot of times what you'll find is that this represents, not necessarily if this occurs through. So if we see that the ATR increases Drastically through a major portion of market structure, then that's an argument for a breakout or a trend change. So you see that over here, market structure, high, high, high. In this case, the ATR went from compression to very large expansion, and it went through market structure. There's an argument for a trend change, okay, not for necessarily some type of trend reversal or fading this move, but when you're ranging. So when you're ranging up here, when you're ranging down here, down here, Using the ATR for a mean reversion tool is an extremely beneficial way about trying to identify those periods where the market might be worth fading rather than jumping on the trend. When you have a move that occurs upward in $300 in a matter of hours using this $300 ATR. So this might be coming to a point where if we see that this portion is the area to break through for the new trend change or for the beginning of a new major bullish leg, the case to be made might be made for seeing that. Let's say right around here, the ATR is right around 300. If we see a move that comes through this area and the ATR goes from 300 to, let's say, 600 or 700, then you're talking in terms of multiples. And if we're coming through market structure, that might not necessarily be worth something fading for the long run. So if we come through and we're two times the atr, and it's just something to think of because now we have two variables, so we have the ATR and this market structure, that is going to likely signify a regime change in this case. So a move through here that occurs in a short amount of time and is two times this ATR before this breakout, that might mean revert temporarily. But in this case, do you want to use that move to mean revert on the assumption it's going to come down further and come back to these norms, or do you want to consider that maybe, since this is an outside of the normal standard deviation movement and it's through market structure, is that portion where we have a tremendous increase in volatility, a signal that the trend is changing? So obviously you have to be careful how you apply this, but when you apply it on the lower time frames and you're looking at the current atr, if you have a move that is outside of the daily ATR on something like a half hour, an hourly chart, in a short amount of time, typically the market moves up and down a lot. So you'll see that those are worth fading. So if you have a move up, worth selling, if you have a move down, worth buying, on the assumption that the market's going to correct and return back to norms. So that's that, guys. Hopefully that has been informative. If you have any questions, as always, feel free to reach out. This is Ryan with block roots. Exercise proper risk management, trade effectively and stay sharp.