Assessing Cryptocurrency Volatility: An Introduction to the ATR Indicator

ATR, or Average True Range, represents a volatility indicator that displays how the price changes within a specific timeframe. However, it does not provide information about the direction of movement, the strength of growth, or overbought or oversold conditions. Instead, it statistically represents the historical price behavior of a cryptocurrency, empowering traders to make well-informed investment decisions.

ATR primarily serves as a supplementary tool to manage losses effectively. It becomes particularly useful for managing risks through setting stop orders, especially stop-loss orders, which are crucial when dealing with highly volatile assets like cryptocurrencies.

To calculate the ATR indicator, one must find the true range, which involves identifying the largest value among three numbers: the difference between the minimum and maximum values on the chart for the chosen timeframe (daily, weekly, monthly, etc.), the difference between the maximum of the current session and the closing price of the previous session, and the difference between the minimum of the current session and the closing price of the previous session.

For instance, let’s consider the daily chart of Bitcoin:

To calculate the true range for July 18, 2023, follow these steps:

The difference between the minimum ($29,521) and maximum ($30,244) of the trading session on July 18 is $723. The difference between the maximum of the July 18 session ($30,244) and the closing price of the previous day ($30,154) is $90. The difference between the minimum of July 18 ($29,521) and the closing price of July 17 ($30,154) is $633. Among the three values obtained ($723, $90, and $633), the first one is the largest and represents the true range. To obtain the average value, the indicator is calculated for each specific day (hour, week, month), and then the arithmetic mean is determined. However, this calculation is typically automated on trading platforms, as the ATR indicator is widely popular and available.

The classical ATR calculation scheme described above was proposed by the creator of ATR, Wells Wilder Jr., in the late 1970s. However, in 2023, many traders consider the true range not as the largest of the three values but simply as the difference between the daily high and low. This alternative approach is also valid, especially for cryptocurrencies on longer timeframes (daily, weekly, and monthly) where there are minimal visual gaps (price discontinuities on the chart). Wilder primarily researched commodity markets, where gaps occurred more frequently, making the classical ATR calculation more appropriate.

Regarding the visual representation, the ATR indicator is commonly available on trading platforms and helps traders make decisions based on the cryptocurrency’s historical price volatility.

How to Use ATR There are two main ways to apply ATR. The first is to determine the presence of a trend. While ATR does not indicate the direction of movement, a higher ATR value often corresponds to increased price changes, indicating stronger volatility, which is often associated with a trend.

For example, from June 15 to June 23, Bitcoin experienced an uptrend, rising from $24,756 to $31,458. During the same period, the ATR indicator also increased. Starting from June 24, the ATR began to decline as BTC traded sideways, resulting in lower volatility.

The chart illustrates the 14-day ATR of Bitcoin, with orange arrows showing the growth of both BTC and the indicator, while purple arrows indicate sideways movement and the decline of the ATR.

However, it is essential to note that precise advice cannot be given solely based on ATR, as the decision to trade or invest depends on your individual approach.

A more interesting use of ATR is for setting stop orders to limit risks. The indicator shows the average price movement over a given time period. Thus, one can assume that the price is unlikely to change more than the average value. Some traders use a ratio of 2ATR or 4ATR to avoid unnecessary trade closures.

For example, if the 14-day ATR is currently $790, and the Bitcoin price on Bitstamp exchange on July 19 is $29,920, you can consider buying BTC at the market price ($29,920) and setting a stop order at $29,130 ($29,920 – $790). If you are willing to take more risk, you may place a stop-loss at $27,550 (current price – 2 ATR) or $26,760 (current price – 4 ATR).

There is another application of ATR for day traders. Let’s say the closing price on July 19 is $30,000, and on July 20, within the first hours of trading, it jumps to $33,500. Your ATR is $790, which is 4.4 times smaller than the previous value. What is the most probable future scenario? A decline. Therefore, you might consider opening a short position. ATR works similarly in the opposite direction.

Most platforms default to a 14-day ATR, but you can adjust the parameters as needed. Since cryptocurrencies vary in quantity and volatility, you will need to choose your own specific parameters for each one.

Despite its advantages, ATR has certain limitations. It is essential to know when not to rely solely on it and consider other indicators and factors for a comprehensive trading strategy.

Disclaimer: The information provided in this material is not intended as individual or any other form of investment advice. The opinions expressed may not coincide with those of the author, analytical portals, or experts.