Today we show how to use the ATR indicator to calculate your stop loss. Average True Range (ATR) indicator calculates the average candles ranges over a specified period.
So ATR measures volatility and includes also any gaps in the price movement. Typically, the ATR calculation is based on 14 periods.
Are you searching a tutorial to programming and create the Average True Range Indicator? Choose your platform and start with your tutorial.
ATR to calculate the Stop Loss
Every time you are choosing your entry size, you need to take into account the price volatility.
Remember that the ATR calculates only the historic volatility and that it can’t predict the future. You have also to consider that generally, volatility is mean-reverting.
First of all, we have to figure out the correct indicator length.
Three different ATR periods with Apple Stock in TradeStation charts
As you can see, with a short ATR period the indicator became too erratic.
Generally, we use the 20 periods in a daily chart instead of the 14 periods.
Charting the Average True Range StopLoss
Charting the Average True Range is very useful for every trading strategies.
In the last days of 2018, your ATR stop loss has become very large.
You can use this indicator to set three different “visual stoploss” levels, you can use this to trailing your position.
An useful indicator that is based on the Average True Range is the SuperTrend Indicator.
The diffence is that the SuperTrend is based on medium prices.
How to calculate the position size using ATR Stop Loss
The last step is to calculate your entry size. Before calculating it, we need to decide our stop loss in money.
For example, we have a 20.000$ account and we would like to risk only 200$ for trades, how many shares can we buy?
POSITION SIZE = DOLLAR STOP LOSS / ( PRICE CLOSE – ATR STOP LOSS )
So if I decide to buy Apple stocks:
- My StopLoss in money is 200 $
- Last Apple Price Close is 197 $
- Last Apple Price Low is 192
- ATR (20) is 4.50 $
- 2 times ATR is 9.00 $
- The volatility increasing
N° of STOCKS = Money Stop loss / ( Price Close – (Price Low – 2 times ATR ) )
N° of STOCKS = 200 $ / ( 197 $ – (192 $ – 9) ) = 14 Stocks
14 Apple Stocks for a total market exposure of 2.758 dollars with a 200$ risk.
With this Excel Spreadsheet you can easily calculate your stoploss based on ATR.
As you can see in the spreadsheet there are 3 different StopLoss:
– 1° = Low Price – Average True Range
– 2° = Low Price – Average True Range x 2
– 3° = Low Price – Average True Range x 3
The spreadsheet also calculate the number of share based on the maximum stoploss in dollar or the number of Lots for forex traders.
Download this Excel file for free:
How to identify the volatility phases in a trading system?
Using this method, when volatility increase, your position decrease. Generally, it’s correct.
But what’s happening before a strong breakout? The volatility became very low so your position could be larger than normal at the moment of the breakout.
You are entering a storm with a big position and it’s dangerous. You can reduce this problem by increasing the length of the Average True Range.
Another solution can be to use different multiplier ATR for different volatility phases.
To do this calculation, we need to compare the actual ATR with the older values. For this purpose, the trading system needs to analyze two different ATR periods, for example, 20 and 60.
ATR Volatility Phases in TradeStation charts
When the ATR 20 is over the ATR 60 the volatility is high (red color), in this scenario, the multiplier is ok.
When the ATR 20 is under the ATR 60 the volatility is low (green color), there isn’t the multiplier.
ATR Stop Loss with Volatility Phases in TradeStation charts
Consequently, you have a system that decreases your market exposure more when the volatility is high, that’s correct. But remember that when volatility is too low the breakout could be near and you should decrease your position size.
If you want download this indicator, choose your platform:
- SuperTrend Multi Time Frame Indicator
- How to AutoTrade Divergences
- SuperTrend for TradeStation and MultiCharts
INVESTOPEDIA: Average True Range