Average True Range
Definition
Average True Range (ATR) measures how much a stock or market typically moves over a set number of periods — it's a pure volatility reading, not a direction signal.
Example
“The stock had a 14-period ATR of $1.20, so placing a stop only 30 cents away was just asking to get shaken out by normal noise.”
Detailed Explanation
ATR was developed by J. Welles Wilder and measures the average of the true ranges over your chosen lookback period. True range accounts for gaps, which is why ATR is more accurate than just measuring candle body size. A rising ATR means the market is expanding — bigger swings, more opportunity, but also more risk. A contracting ATR means it's getting quiet, which can precede a big move or just mean nothing interesting is happening.
The most practical use of ATR is stop placement. If you set stops based on a fixed dollar amount without checking ATR, you'll get stopped out constantly on high-volatility names and leave way too much room on slow movers. A better framework: set your stop at 1x to 1.5x ATR below your entry on longs. This way you're giving the trade room to breathe relative to its normal movement, not an arbitrary number you picked from thin air.
ATR is also useful for sizing positions. If you risk $100 per trade and ATR says the stock normally moves $2 a day, you can use that to calculate appropriate share size so one bad day doesn't exceed your risk tolerance. Traders who use ATR for both stops and sizing tend to have much more consistent loss control than those who eyeball it.