How to calculate the ATR volatility? How to adjust the stop loss range?

The Average True Range (ATR) is a technical analysis indicator that measures market volatility by decomposing the entire range of an asset price for that period. Specifically, in the cryptocurrency market, understanding and calculating the ATR can be instrumental in adjusting stop loss ranges to manage risk effectively. This article will guide you through the process of calculating the ATR and how to use it to adjust your stop loss range in trading cryptocurrencies.

Understanding the Average True Range (ATR)

The Average True Range is calculated by taking the average of the true ranges over a specified period, typically 14 days. The true range is the greatest of the following: the current high minus the current low, the absolute value of the current high minus the previous close, and the absolute value of the current low minus the previous close.

To calculate the ATR, you need to follow these steps:

• Determine the True Range for each period: For each day, calculate the true range by finding the maximum value among the following three calculations:

  • The difference between the current high and the current low.
  • The absolute value of the difference between the current high and the previous closing price.
  • The absolute value of the difference between the current low and the previous closing price.

• Calculate the first ATR value: Once you have the true ranges for the initial period (e.g., 14 days), the first ATR is simply the average of these true ranges.

• Calculate subsequent ATR values: For each new period, you use the formula:

  ATR = [(Previous ATR  13) + Current True Range] / 14

  This formula smooths out the ATR, providing a more stable measure of volatility over time.

Applying ATR to Cryptocurrency Trading

In the volatile world of cryptocurrencies, the ATR can be an invaluable tool for traders. It helps in setting more dynamic stop losses that adjust according to the market's volatility.

To apply ATR in trading cryptocurrencies, you first need to calculate the ATR over a chosen period. Many trading platforms and charting tools offer built-in ATR indicators, but understanding how to calculate it manually can provide deeper insight into its workings.

Adjusting Stop Loss Range Using ATR

Adjusting your stop loss range using ATR involves using the ATR value to set a stop loss that reflects the current market volatility. Here's how you can do it:

• Determine the ATR value: Use the method described above to calculate the ATR for your chosen cryptocurrency over a specific period.

• Set the stop loss distance: A common approach is to set the stop loss a certain multiple of the ATR away from the entry price. For example, if the ATR is 100 and you decide to set your stop loss at 2x the ATR, your stop loss would be 200 points away from your entry price.

• Adjust the stop loss as the ATR changes: Since the ATR is a moving average, it will change over time. As the ATR increases, indicating higher volatility, you might need to move your stop loss further away from your entry price to avoid being stopped out prematurely. Conversely, as the ATR decreases, you can bring your stop loss closer to lock in profits.

Practical Example of Using ATR to Adjust Stop Loss

Let's consider a practical example with Bitcoin (BTC). Suppose you enter a long position on BTC at $30,000, and the current 14-day ATR value is $500.

• Calculate the stop loss: If you decide to set your stop loss at 2x the ATR, your stop loss would be:

  Stop Loss = Entry Price - (2  ATR) = $30,000 - (2 * $500) = $29,000

• Monitor and adjust: As the market moves and the ATR changes, you should recalculate the ATR daily or weekly and adjust your stop loss accordingly. If the ATR increases to $600, your new stop loss would be:

  Stop Loss = $30,000 - (2 * $600) = $28,800

Considerations When Using ATR for Stop Loss

When using ATR to adjust your stop loss, it's important to consider the following:

• Market conditions: The ATR reflects the market's volatility, which can change rapidly, especially in the cryptocurrency market. Be prepared to adjust your strategy as market conditions evolve.

• Timeframe: The ATR value can vary significantly depending on the timeframe used. A shorter timeframe might result in a lower ATR, leading to tighter stop losses, while a longer timeframe could result in a higher ATR and wider stop losses.

• Risk tolerance: Your risk tolerance should influence how many ATR multiples you use to set your stop loss. More conservative traders might opt for a higher multiple of the ATR to give their trades more room to breathe.

Using ATR in Different Trading Strategies

The ATR can be integrated into various trading strategies within the cryptocurrency market. For instance, in trend-following strategies, traders might use the ATR to set trailing stops that move with the price, ensuring they capture as much of the trend as possible while still protecting profits.

• Trend-following strategy: If you're in a long position and the price is moving in your favor, you can use the ATR to set a trailing stop that adjusts automatically. For example, if the price of BTC moves to $31,000 and the ATR is still $500, you might set your trailing stop at:

  Trailing Stop = Current Price - (2 * ATR) = $31,000 - (2 * $500) = $30,000

• Breakout strategy: In a breakout strategy, the ATR can help you determine the strength of a breakout. A high ATR during a breakout could indicate a strong move, prompting you to set a wider stop loss to give the trade more room to develop.

FAQs

Q1: Can the ATR be used to predict future price movements in cryptocurrencies?

A1: The ATR is a measure of volatility and not a predictive tool. It can help you understand the current market conditions and adjust your trading strategy accordingly, but it does not predict future price movements.

Q2: How often should I recalculate the ATR for my stop loss adjustments?

A2: The frequency of recalculating the ATR depends on your trading strategy and the timeframe you are using. For short-term traders, daily recalculations might be necessary, while long-term traders might recalculate weekly or monthly.

Q3: Is there an ideal multiple of ATR to use for setting stop losses?

A3: There is no one-size-fits-all answer to this question. The ideal multiple of ATR to use for setting stop losses depends on your risk tolerance, trading strategy, and the specific cryptocurrency you are trading. Some traders might use 1x the ATR, while others might use 2x or 3x.

Q4: Can the ATR be used effectively in highly volatile cryptocurrencies like altcoins?

A4: Yes, the ATR can be particularly useful in trading highly volatile altcoins. It helps in setting stop losses that are more reflective of the market's current volatility, which can be crucial in managing risk in such markets.