The Art of ATR

ATR stands for “average true range.”

The ATR measures the dollar volatility of a stock/instrument.

Using ATR in a trading system quantifies the trading process and eliminates emotional decision making.

ATR provides an unbiased answer to the following questions:

• How many shares should I buy?
• When should I sell and take a loss/How far do I let a losing trade go?
• How/when do I win and book profits?

Before these questions can be answered, you must first determine your dollar risk per trade.  

When I trade stocks, I’m willing to risk 1-2% per trade(probably closer to 1% because stocks are highly correlated to each other--if the broad market falls, most stocks fall with it). This means in any given trade, my projected worst-case-scenario is that I will lose 1-2% of my account.

This doesn't mean that I buy as much stock as I can get with 1-2% and allow the stock to fall to zero.

Instead, this means I determine how volatile a stock is and allow X units of volatility to go against me. 

I divide my risk per trade by the number of units of volatility I’m comfortable with (in my case, I like using 10ATR) and this let me know how many shares I should buy(always round down to the nearest number).

I’ll sell when a trade moves 10 units of ATR against me from any given peak price.

This means at worst, I will enter a trade, and it falls 10ATR and stops me out.

But this also means that a trade could appreciate 100% and fall 10ATR from its peak price and I’ll still book a solid win. The whole key for me is 10 units of ATR.     

I could write all day about ATR, but I want to make my material somewhat palatable, so instead of overwhelming you with all this info, I’m going to cut this article short.

If you are willing to learn about how to calculate ATR and apply it to your trading, I’m willing to help you conceptualize it. Its really simple once you jump in and commit to learning(I use barchart.com to do all the ATR calculations for me, so the real key is not in its calculation, but its application.)

**Remember, its all about the system, not any particular trade.

***Books I’m digging into in order. Already half way through the first book and it is a snooze-fest, but necessary as I want to create my own trading algorithms. If you want summaries of any of these books or if you’ve read any and want to discuss, hmu.