If you’ve ever traded or followed the markets, you know that it’s hard to find opportunities in a low-volatility environment. While volatility is hard to gauge, there are several indicators out there to help you determine whether a stock can run higher or if it’s losing steam.
The Average True Range (ATR) is one way to gauge daily volatility, and can indicate that a stock may be starting to build momentum, or be reverting to the mean.
Average True Range (ATR)
The ATR is usually based on a rolling 14-period window, and can be calculated using intraday, daily, weekly or monthly price data. The current ATR, in this context, is quite simply the prior ATR multiplied by 13 and the current true range is added. Thereafter, that value is divided by the number of periods used (14 in this case).
I’ll skip all the mathematics behind this calculation because most charting and trading software already has it built in. All you have to do is change the period to your liking and whether the data set (intraday, daily, etc.) that you want to use. Now, keep in mind that the ATR does not indicate where the stock may be headed, rather, it just gives traders an idea of whether the stock is in a high volatility or low volatility environment.
Let’s take a look at an example.
Take a look at Facebook Inc. (FB). If you look at the 30-minute chart below, you’ll notice that the ATR in FB was rising, but did not give a clear indication of the direction the stock might go.
Instead, in this context, you get a hint that the stock could move around 68 cents.
That said, if you noticed this, you could have realized that FB’s price moved too far too fast, and it may have reverted back to the mean after the price drop. You could notice that once the price moved more than its ATR and hit the $145 level, it found some support and rebounded. Again, you aren’t getting an indicator of direction, but a signal that might be used as a mean-reverting strategy.
On the other hand, look at the SPDR Gold Trust (GLD), specifically at the ATR area outlined by the rectangle.
Here, GLD actually moved less than its ATR at some points, which could be an indication that momentum would start building in either direction.
ATR can be a good indicator of whether a stock is likely to mean revert or build momentum, but keep in mind that all it tells you by itself is the amount — and not the direction — you can expect a security to move. Only when you use ATR in conjunction with other technical indicators do you have a chance to decide which way a security is likely to go next.