What is ATR? Average True Range explained, with stop-loss examples

The Average True Range is a volatility indicator introduced by J. Welles Wilder Jr. in 1978, in the same book as RSI. It answers a practical question: how far does this asset usually travel in one period? A stock with an ATR of $2 typically covers about $2 between its daily high and low; if the ATR doubles, the market has become twice as jumpy.

Wilder designed it for commodity markets, where prices often gap from one session to the next. That is why it uses the 'true' range rather than the simple high–low range: a gap is volatility too, even if it happened while the market was closed.

First compute each period's true range (TR), then smooth it — over 14 periods by default:

TR  = max(high − low, |high − prev. close|, |low − prev. close|)
ATR = (previous ATR × 13 + today's TR) ÷ 14

Example: yesterday's close was 48 and today's high and low are 52 and 49. The high–low range is only 3, but measured from the previous close the move is |52 − 48| = 4, so TR = 4. If the previous ATR was 2.50, the new ATR is (2.5 × 13 + 4) ÷ 14 ≈ 2.61. Our charts use this 14-period Wilder version.

Because ATR tracks normal noise, it helps place stop-losses outside that noise. Say you buy a stock at $50 with an ATR of $2.50. A stop two ATRs below entry sits at 50 − 5 = $45: far enough not to be hit on an ordinary day, close enough to cap the loss. If you are willing to lose $500 on the trade, position size = 500 ÷ 5 = 100 shares. A more volatile asset automatically gets a wider stop and a smaller position.

ATR also helps compare instruments. Dividing by price gives ATR%: $2.50 on a $50 stock is 5% a day, while $30 on a $3,000 stock is just 1%. A rising ATR during a sell-off is typical — fear widens ranges — while a very low ATR often comes before a breakout.

ATR says nothing about direction: it rises in crashes and rallies alike. It is also backward-looking, so a sudden shock — earnings, a central-bank surprise — can produce a move several ATRs wide before the indicator catches up.

Because it is expressed in price units, ATR values can't be compared across assets or very different price levels without converting to ATR%. And a stop 'two ATRs away' still doesn't protect against gaps: if a stock opens far below your stop, the order fills at the next available price.