Average True Range (ATR): measuring volatility for stops and sizing

Average True Range (ATR) is an indicator that measures how much a stock typically moves in a period, expressed in dollars. It was introduced by J. Welles Wilder Jr. in 1978 and takes gaps into account, which a simple high-to-low range misses. ATR does not show direction. Its job is to answer "how big are this stock's normal swings?", which helps with placing stops and sizing positions.

The formulas

True Range = the largest of:
             High - Low
             |High - Previous close|
             |Low - Previous close|

ATR (first value) = average of the first 14 True Ranges
ATR (afterwards)  = (Previous ATR x 13 + Today's True Range) / 14

True range is the key step. If a stock closes at $100 and opens the next morning at $104 before trading in a tight range, the high-low range alone would look small even though price effectively moved $4. Including the distance from the previous close captures that gap. The 14-period setting is the default, and the smoothing is Wilder's method, so values may differ slightly from platforms that use a simple average instead.

Example (illustrative numbers)

The previous close was $100. Today the stock opens higher, trades between $101 and $104, and the previous day's ATR was $2.00.

High - Low             = 104 - 101 = 3
|High - Previous close| = |104 - 100| = 4
|Low - Previous close|  = |101 - 100| = 1

True Range = 4

New ATR = (2.00 x 13 + 4.00) / 14 = 30 / 14 = $2.14

One unusually wide day moves the ATR only a little, because it averages across many days. ATR reacts slowly to a sudden burst of volatility and slowly to a return to calm.

Putting ATR in perspective

ATR is in dollars, so it depends on the stock price. A $2 ATR is a small move for a $200 stock and a huge one for a $10 stock. To compare stocks, divide by the price:

ATR % = ATR / Price x 100

An ATR of $2 on a $100 stock is 2%; the same $2 on a $20 stock is 10%. Higher ATR% means larger typical daily swings and more risk per share.

Using ATR for stop distance

A stop placed too close to the current price is triggered by ordinary noise. One common approach is to set the stop at a multiple of ATR from entry, such as 2 times ATR. The reasoning is that price must move more than its usual range to hit the stop. A variation is a trailing stop that sits a multiple of ATR below the highest close since entry.

The multiple is a judgment call: a tighter multiple gives smaller losses but more frequent stop-outs, and a wider one gives price more room. There is no universally correct multiple. For the broader debate, see stop-loss orders: pros and cons.

Using ATR for position size

ATR also lets you hold the dollar risk of a trade roughly constant across different stocks:

Shares = Amount you are willing to lose / Stop distance per share

Example (illustrative numbers): an investor decides to risk $500 on a trade, an arbitrary figure chosen for this example, not a recommendation. A stock trades at $100 with an ATR of $2, and the stop is set at 2 times ATR, which is $4 below entry.

Shares = $500 / $4 = 125 shares  (position value $12,500)

If the stock were more volatile, with an ATR of $4, the stop distance would be $8 and the same $500 risk would allow only about 62 shares. Higher volatility means a smaller position for the same dollar risk. This is the logic behind volatility-based position sizing, discussed further in position sizing.

Other ways to read ATR

• Rising ATR means swings are getting larger. This often accompanies sharp declines, news events or breakouts.
• Falling ATR means swings are shrinking, as happens in quiet consolidations. Compare with a Bollinger Band squeeze, which measures a related idea from closing prices.
• Buffers. Chart readers sometimes require a close beyond a level by some fraction of ATR before calling a move a breakout, which reduces false signals. See breakouts and false breakouts.

Common mistakes and limits

• Confusing size with direction. A high ATR can come from a rally or a crash. It does not signal which.
• Assuming a stop guarantees an exit price. A stop can fill well beyond its level if a stock gaps overnight, for example after an earnings report. ATR describes past typical movement, not the worst case.
• Treating it as stable. ATR is backward-looking and averaged, so it can lag when volatility changes quickly. A stock heading into earnings may move much more than its ATR suggests.
• Mixing time frames. The ATR of a weekly chart is much larger than that of a daily chart. Use the one that matches how long you intend to hold.
• Using the same multiple everywhere. Different stocks and market conditions call for different judgments about how much room to give.

Where to see it on StocksXray

Stock pages show a price chart with indicators and a technical summary, which together help you judge how a stock has been behaving. ATR is most useful as a personal planning tool, applied after you have identified a stock worth researching.

Key takeaways

• True range includes the gap from the previous close, and ATR is a smoothed average of it, typically over 14 periods.
• ATR measures the typical size of moves in dollars, not their direction.
• Dividing ATR by price lets you compare volatility across stocks.
• Stop distance and position size can both be tied to ATR so that normal noise does not trigger exits and risk per trade stays consistent.
• ATR is backward-looking, and gaps can carry price beyond any stop.