This guide explains how ATR is calculated, the main ways to use it in a strategy, worked examples, and how to automate and test ATR-based rules.
At a glance
| ATR-based trading | |
|---|---|
| Purpose | Adapt stops, targets and position size to volatility |
| Instruments | Any: indices, futures, stocks, commodities |
| Indicator | ATR, usually over 14 periods |
| Common uses | Stops at 1.5 to 3 times ATR, sizing by ATR, volatility filters |
| Works with | Almost any entry signal |
How ATR is calculated
ATR was introduced by J. Welles Wilder Jr. in 1978. It starts with the true range of each candle, which is the largest of:
- The candle's high minus its low.
- The distance from the previous close to the high.
- The distance from the previous close to the low.
Including the previous close captures gaps. If a stock closes at ₹500 and the next day trades between ₹510 and ₹518, the high-low range is only ₹8, but the true range is ₹18, because the price gapped up from ₹500.
ATR is the average of the true range over a set period, usually 14, smoothed with Wilder's method. A 14-day ATR of ₹20 means the stock has typically moved about ₹20 a day over the last few weeks.
Use 1: Stops based on ATR
A fixed stop, such as 1% or 50 points, is too tight on volatile days and too loose on quiet ones. An ATR stop scales with volatility:
- Initial stop: entry price minus 2 times ATR for a long trade.
- Trailing stop: the highest price since entry minus 3 times ATR, sometimes called a chandelier stop.
Example. Nifty futures have a 15-minute ATR of 22 points. A long entry at 25,080 with a 2-ATR stop puts the stop at 25,036. On a calmer day with an ATR of 12, the same rule gives a 24-point stop at 25,056.
Use 2: Position sizing with ATR
ATR sizing keeps the rupee risk of each trade roughly constant:
Position size = rupees you are willing to risk ÷ (stop multiple × ATR).
Example. You risk ₹5,000 per trade with a 2-ATR stop. A stock with an ATR of ₹12 gets 5,000 ÷ 24 ≈ 208 shares. A more volatile stock with an ATR of ₹40 gets 5,000 ÷ 80 = 62 shares. Each position risks about the same amount. The position size calculator does this for you.
For futures and options, round down to whole lots. If the result is less than one lot, the trade is too large for your risk limit.
Use 3: Targets based on ATR
Targets can also scale with volatility, such as 3 times ATR from entry. This keeps the reward-to-risk ratio consistent: a 2-ATR stop and a 3-ATR target give a 1.5 to 1 ratio on every trade.
Use 4: Volatility filters
ATR can switch strategies on and off:
- Skip quiet markets for breakout strategies, for example if ATR is below its 50-period average.
- Skip wild markets for mean reversion strategies, for example if ATR is more than 1.5 times its average.
- Compare instruments by ATR as a percentage of price, to see which are more volatile.
A complete ATR-based rule set
This example combines an entry signal with ATR stops, sizing and targets:
- Entry: buy when the price closes above the 20-day high (a Donchian breakout).
- Size: risk 1% of capital, with the stop at 2 times the 14-day ATR.
- Initial stop: entry minus 2 × ATR.
- Trailing stop: highest close since entry minus 3 × ATR.
- Filter: only enter if the 14-day ATR is above its 50-day average, so the market is active.
ATR in other indicators
ATR is the building block of several popular tools:
- Supertrend places its line a multiple of ATR from the candle midpoint.
- Keltner Channels draw bands a multiple of ATR around a moving average.
- Chandelier exits trail a stop a multiple of ATR below the highest high.
Limits of ATR
- ATR is backward-looking. It measures past volatility and reacts slowly to sudden changes.
- ATR has no direction. A high ATR can mean a strong rally or a crash.
- Gaps can exceed it. An overnight gap can move the price far more than one or two ATRs, past any stop.
Automating ATR rules
ATR stops and sizes change with every candle, which is tedious to calculate by hand and easy to automate. QuantPower's strategy builder lets you combine indicator-based entries with stops, targets and trailing exits. Test your rules in the backtesting engine and paper trading before going live.
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Connect your broker, build a strategy and test it on paper before a single live order goes out.
Backtesting tips
- Use the ATR known at the time of each decision, not one calculated later.
- Test several multiples, such as 1.5, 2 and 3 for stops.
- Include gaps. Use daily data with real opens, so gap losses beyond stops appear in the results.
Frequently asked questions
What is a good ATR multiple for a stop loss?
Many traders use 1.5 to 3 times ATR. Smaller multiples get stopped out more often; larger ones risk more per trade. Test on your strategy.
What ATR period should I use?
14 is the standard. Shorter periods react faster to changes in volatility; longer periods are smoother.
Can I use ATR for options?
Yes, on the underlying, to set stops or filters based on the index's volatility. Option prices also depend on implied volatility, which ATR does not measure.
Is a high ATR good or bad?
Neither. High ATR means larger moves, which suit breakout strategies but need wider stops and smaller positions.
Sources
- Wilder, J. W. (1978). New Concepts in Technical Trading Systems. Trend Research