1-ATR: Improving Your Trading
Average true range (ATR) is a volatility indicator that shows how much an asset moves. The indicator can help day traders confirm when they might want to initiate a trade. It’s also used to determine the placement of a stop-loss order.
The ATR indicator moves up and down as price moves in an asset become larger or smaller. A new ATR reading is calculated as each period passes. All these readings are plotted to form a continuous line, so traders can see how volatility has changed over time.
To calculate the ATR by hand, you must first calculate a series of true ranges (TRs). The TR for a given trading period is the greatest of the following:
Current high minus the previous close
Current low minus the previous close
Current high minus the current low
The number of periods used in the calculation is 14.
3-ATR and Trading Decisions
Day traders can plot profit targets and determine whether a trade should be attempted.
Assume a stock moves $1 a day, on average. The stock is already up to $1.20 on the day. The trading range (high minus low) is 1.35. The price has already moved 35% more than the average, and now you're getting a buy signal from a strategy.
The price is more likely to fall, staying within the price range already established. While buying isn't prudent, selling or shorting is probably the better choice.
The opposite could also occur if the price drops and is trading near the low of the day and the price range for the day is larger than usual. I have a sell signal, you should ignore it or take it with extreme caution. More likely the price will move up and stay between the daily high and low already established. Look for a buy signal.
Don’t forget to review historical ATR readings as.
4-Day Trading ATR
If you're using the ATR on an intraday chart, the ATR will spike higher right after the market opens. The open is the most volatile time of day, and the ATR indicates that volatility is higher than it was at yesterday's close.
Day traders can use the one-minute ATR to estimate how much the price could move in five or 10 minutes. It may help establish profit targets or stop-loss orders.
If the ATR on the one-minute chart is 0.03, then the price is moving about 3 cents per minute. If you're forecasting the price will rise and you buy, you can expect the price is likely to take at least five minutes to rally 15 cents.
This type of analysis aids in formulating expectations on what will occur. Studying the ATR shows the real movement tendencies of the price.
5-ATR Stop Loss
A rule of thumb is to multiply the ATR by two to determine a reasonable stop loss point.
So if you're buying a stock, you might place a stop loss at 2 x ATR below the entry price. If you're shorting a stock, you would place a stop loss at 2 x ATR above the entry price.
If you're long and the price moves favorably, continue to move the stop loss to 2 x ATR below the price. In this scenario, the stop loss only ever moves up, not down.
For example, a long trade is taken at $10, and the ATR is 0.10. You would place a stop loss at $9.80. The price rises to $10.20, and the ATR remains at 0.10. The stop loss is now moved up to $10, which is 2 x ATR below the current price. When the price moves up to $10.50, the stop loss moves up to $10.30, locking in at least a 30 cent profit on the trade. Amazing right?
ATR is a perfect strategy simulator in smart trades.
Keltner Channels are a combination of two other indicators: the exponential moving average (EMA) and the average true range (ATR).
The moving average is the average price for a certain number of periods. The average true range is a measure of volatility that was created by J. Welles Wilder Jr.
The true range for a given day is the greatest of the following: the current high minus the current low, the absolute value of the current high minus the previous close, or the absolute value of the current low minus the previous close.
Here is how Keltner Channels are calculated:
Upper Band = EMA + (ATR x multiplier)
Middle Band = EMA
Lower Band = EMA - (ATR x multiplier)
The EMA period can be set to anything you want. For day trading, an EMA of 15 to 40 is typical.
A common multiplier for the ATR is 2, meaning the upper band will be plotted 2 x ATR above the EMA, and the lower band will be plotted 2 x ATR below the EMA.
The multiplier can be adjusted based on the asset you're trading.
Buy during an uptrend when the price pulls back to the middle line. Place a stop loss about halfway between the middle and lower band and place a target price near the upper band.
If the price is hitting your stop loss a lot, you can move your stop loss a little closer to the lower band. This hopefully will reduce the number of losing trades you have.
Sell short during a downtrend when the price rallies to the middle line. Place a stop loss about halfway between the middle and upper band and place a target near the lower band. If you find the price is hitting your stop loss a lot, you can move your stop loss a little closer to the upper band.
This strategy takes advantage of the trending tendency and provides trades with an approximate 0.5 risk-reward ratio since the stop loss point is about half the length of the target price length.
The Keltner Channel breakout strategy attempts to capture big moves that the trend-pullback strategy may miss. It should be used near a major market open. That is when the most explosive movement occurs.
You buy if the price breaks above the upper band or sell short if the price drops below the lower band in the first 30 minutes after the market opens. The middle band is used as the exit. There is no profit target for this trade. Just exit the trade whenever the middle band is touched, whether the trade is a loser or a winner.
Since the market is typically volatile right after the open, you may get one signal that results in a loss or small profit, immediately followed by another signal. Trade the second signal as well. Take only two trade signals for this strategy in the first 30 minutes. If a big move doesn't occur on the first two-channel breakouts, then it probably isn't going to happen.
This strategy is best applied to assets that tend to have sharp trending moves in the morning.
The indicator does not include the current price bar in the calculation. In other words, if you choose to apply the indicator over 20 candlesticks, the bands are calculated and plotted based on the 20 prior candlesticks.
For example, assume a trader is using a one-minute chart, and the highest price for stock in the last 20 minutes was $125.50. The lowest price in the last 20 minutes was $125. The indicator will draw an upper line at $125.50 and a lower line at $125. If a mid-band is added, it is drawn at $125.25.
It occurs when the up and down movements of an asset's price are confined to a smaller and smaller area. The price is creating lower swing highs and lower swing lows.
Connecting the swing highs with a trend line and the swing lows with a trend line create a symmetric triangle where the two trend lines are moving towards each other.
A triangle can be drawn once two swing highs and two swing lows can be connected with a trend line. Traders often wait for the price to form three swing highs or lows before drawing the trend lines.
The figure shows several ways various traders may have drawn a triangle pattern on this particular one-minute chart.
It is formed by rising swing lows, and swing highs that reach similar price levels.
When a trend line is drawn along the similar swing highs it creates a horizontal line. The trend line connecting the rising swing lows is angled upward, creating the ascending triangle.
The price is still being confined to a smaller and smaller area, but it is reaching a similar high point on each move up.
An ascending triangle can be drawn once two swing highs and two swing lows can be connected with a trend line.
It is formed by lower swing highs, and swing lows that reach similar price levels. When a trend line is drawn along the similar swing lows, it creates a horizontal line. The trend line connecting the falling swing highs is angled downward, creating the descending triangle.
The price is being confined to a smaller and smaller area, but it is reaching a similar low point on each move down.
A descending triangle can be drawn once two swing highs and two swing lows can be connected with a trend line.
Once you have more than two points to connect, the trend line may not perfectly connect the highs and lows. Draw trend lines that best fit the price action.
The breakout strategy can be used on all triangle types. The breakout strategy is to buy when the price of an asset moves above the upper trend line of a triangle, or short sell when the price of an asset drops below the lower trend line of the triangle.
Since each trader may draw their trend lines slightly differently, the exact entry point may vary from trader to trader. To help isolate when the price is breaking out of the formation, increases in volume can help highlight when the price is starting to gain momentum in the breakout direction.
By assuming the triangle will hold, and anticipating the future breakout direction, traders can often find trades with very big reward potential relative to the risk.
It works like this: assume a triangle forms and a trader believes that the price will eventually break out of it to the upside. In this case, they can buy near triangle support, instead of waiting for the breakout.
By buying near the bottom of the triangle the trader gets a much better price. With a stop loss placed just below the triangle risk on the trade is kept small. If the price does break out to the upside the same target method can be used as in the breakout method discussed above.
False breakouts can help traders take trades based on the anticipation strategy. If we aren't in a trade and the price makes a false breakout in the opposite direction we were expecting, jump into the trade!
For example, assume a triangle forms and we expect that the price will eventually break out to the upside based on our analysis of the surrounding price action. Instead, the price drops slightly below the triangle but then starts to rally aggressively back into the triangle. Consider taking a long trade, with a stop loss just below the recent low. Since the move to the downside failed, it is quite likely that the price will try to go higher, in line with our original expectation.
Trend lines highlight a sideways movement. A trend line connects a swing low to a swing high, from the lowest point of the downward movement to the highest point in the upward movement. When the price rises, the trend line rises accordingly.
Connecting these lows with a line results in an ascending trend line, showing you that the prices are trending upwards. A trend line can also be drawn along the individual swing highs. This shows the angle of ascent, the strength of the price move, and the relative strength of the trend.
When the price falls, the swing highs fall. Connecting these highs with a line results in a descending trend line, illustrating the downward trend. A trend line can also be drawn along the swing lows. This shows the angle of descent and the strength of the downward price movement.
17-Multiple Trend lines
At any given moment you could draw many trend lines, all showing the price movement over various periods.
Trend lines at very steep angles typically have a short life, since prices cannot sustain a near-vertical rise or fall for long.
Drawing trend lines can aid new traders in spotting the overall trend, while also highlighting small trends and corrections within that overall trend.
During an uptrend, buying or going long opportunities may occur when a short-term downtrend meets the overall ascending trend line.
During a downtrend, selling or shorting opportunities may occur when a short-term uptrend meets the overall descending trend line.
18-Adjusting Trend lines
Trend lines work as a tool, and can't be relied on solely. To decide whether a trend line should be adjusted, or whether it has been broken, consider how the price moves within a trend.
During an uptrend, the price makes higher highs and higher lows. As long as that keeps occurring, if the price moves below the trend line it doesn't necessarily mean the trend has ended, the line may just need to be adjusted.
During a downtrend, the price makes lower lows and lower highs. As long as that happens, if the price moves above the descending trend line it doesn't necessarily mean the trend has ended, the trend line might simply need to be adjusted.
19-Trend Lines Guide
Therefore, while you can use trend lines as a guide, use more precise criteria for entering a trade. Move back in the trending direction, an engulfing pattern or an indicator that adjusts more precisely and quickly to changes in volatility.
If you use trend lines as just a guide, then you don't need to worry about drawing trend lines along the exact highs or lows. Draw "trend lines of best fit." The best-fit trend lines still provide you with a visual trend and alert you to potential trade areas.
20-Support and Resistance Levels
Minor support and resistance levels don't hold up. For example, if the price is trending lower, it will make a low, then bounce, and then start to drop again. That low can be marked as a minor support area since the price did stall out and bounce off that level. But since the trend is down, the price is likely to eventually fall through that minor support level without much problem.
Major support and resistance areas are price levels that have recently caused a trend reversal. If the price was trending higher and then reversed into a downtrend, the price where the reversal took place is a strong resistance level. Where a downtrend ends and an uptrend begins is a strong support level.
When buying, place a stop loss several cents (or ticks or pips) below support, and when shorting, place a stop loss several cents, ticks, or pips above resistance.
If you're waiting for a consolidation, place stop loss a couple of pips below the consolidation when buying. When selling, the stop loss goes a couple of pips above the consolidation.
When entering a trade, have a target price in mind for a profitable exit. If buying near support, consider exiting just before the price reaches a strong resistance level.
If shorting at resistance, exit just before the price reaches strong support. You can also exit at minor support and resistance levels. For example, if you're buying at support in a rising trend channel, consider selling at the top of the channel.
If you're buying near triangle support within a larger uptrend, you may wish to hold the trade until it breaks through triangle resistance and continues with the uptrend.
This information is taken from The Balance. It makes personal finance easy to understand. It is home to experts who provide clear, practical advice on managing your money. Whether you’re looking to invest, buy a home, save for retirement, or achieve another financial goal, The Balance’s 20-year-strong library of more than 9,000 pieces of content will answer your questions with straightforward personal financial advice.
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