Developed by J. Welles Wilder, the Average True Range (ATR) is an indicator that measures volatility.
Wilder designed ATR with commodities and daily prices in mind.
Commodities are frequently more volatile than stocks.
They were are often subject to gaps and limit moves, which occur when a commodity opens up or down its maximum allowed move for the session.
A volatility formula based only on the high-low range would fail to capture volatility from gap or limit moves.
Wilder created the Average True Range to capture this “missing” volatility.
It is important to remember that ATR does not indicate the price direction, just volatility.
Wilder started with a concept called True Range (TR), which is defined as the greatest of the following:
Typically, the Average True Range (ATR) is based on 14 periods and can be calculated on an intraday, daily, weekly or monthly basis.
The ATR will be based on daily data. Because there must be a beginning, the first TR value is simply the High minus the Low, and the first 14-day ATR is the average of the daily TR values for the last 14 days.
ATR = (Previous ATR * (n - 1) + TR) / n
ATR = Average True Range
n = number of periods or bars
TR = True Range
The True Range for today is the greatest of the following: