The ATR Advantage

Which is better a high average true range (ATR) or a low one? The answer - it depends on the circumstances. If you are going to day trade and you have two stocks where everything else is equal and you only want to be involved with one of them for whatever reason - pick the one with the highest ATR on the minute-basis you are playing (ATR varies with time scale). You do this because you want the most "bang" for the buck and ATR is a proxy for volatility.

But if you are planning a swing trade and you are faced with several different stocks and can't choose between them then the answer is clear - take the stock with the lowest ATR.

Here are the results of testing done with the ATR set at various levels -


Obviousely the lowest ATR has both a better win percentage and ROI. And you can't help but notice that the ROI deteriorates as the starting ATR increases.

Once more this is a volatility issue - before a stock can go up it has to stop and the ATR tells you when a stock is slowing down or "stopping".

One other thing you have to remember is that ATR is also relative to the price of the stock - that is - low priced stocks have naturally low priced ATR and high priced stocks have naturally high priced ATR. So you really can't use ATR across price boundaries.

Remember also - ATR is a guide not a guarantee - trading stocks is a risky business.

Volatility Is King

Long time readers know that I hold the average true range as the key to volatility. Any other so-called volatility such as the VIX, VXN, or VXO are pretenders in my humble opinion.

Long time readers also know that whenever I make a bold statement I try to back it up with evidence - here is the evidence -


You can see where the ATR was during the "bubble" of the 90's. It began below 600 (monthly charts please) and then slowly climbed to over 900. 900 seemed to be the catalyst for the fall because once it broke 900 there was too much volatility and not enough liquidity to sustain the price and the market fell.

We've seen this picture on this BLog before - most notably on the daily basis since the 27th of February. You can see that the ATR did not break until the market bottomed - at that point it began to fall in a significant manner and the market resumed its climb. Notice too that well before the market completed its fall that volume was cut almost in half.

Now a lot of people are going to be saying all kinds of doom and gloom crap about Dow at 13000. All you need to remember is that the only number that matters is the ATR at 505.

And I know that there are hundreds of people, maybe even thousands who would disagree with my every statement - but none of them can produce a picture like I can.

But always keep Rule 1 firmly in mind - nobody knows nothing - including me.

ATR - Potent Tool

I know - I get hold of an idea and I don't want to let it go but I was playing around this morning with a couple of filters and I had a thought on how to improve my Blow-Off Bottom set-up filter.

That filter as you probably remember only outputs stocks that meet the first two-thirds of the BOB set-up and it's up to you to watch for the third third to develop and perhaps use that to day trade (or start a new, longer-term relationship).

Anyway I added a constraint that said - and ATR(10) is less than ATR(10) 2 days ago and I back tested the modification.

The results are interesting enough on the surface -

Original BOB Set-up: 58% Win rate, 27.74% ROI
Modified BOB Set-up: 58% Win rate, 66.76% ROI

Apparently the ATR makes a difference and I'm going to leave it in - but this is the newsworthy part - when I looked at the net change over time here is what I found.

Original BOB Set-up: 4 day change = .34%, 30 day change 1.51%
Modified BOB Set-up: 4 day change = .80%, 30 day change 5.76%

That is amazing. Over double on the 4 day and nearly 4 times on the 30 day.

What this says, at least to me, is that an ATR that is high and then begins to decline is potent tool for the trader's tool box.

As always I tested the counter proposition just as a sanity check and here are the results from when I required the ATR to be increasing over the ATR of 2 days ago.

Win% = 54%, ROI = -6.28%, net change over 4 days = -.05%, over 30 days 1.44%.

That clinches the deal as far as I'm concerned - a decreasing ATR (= decreasing volatility) is better for your trading account than an increasing ATR (= increasing volatility).

Some months ago I wrote a post that provided an anecdotal indicator that when trying to choose between two stocks for a day trade and only having enough bullets or desire to trade one that you should take the one with the higher ATR. This is why. This tool will help you on all time frames. And maybe even if you do have enough to cover both you should put is all in on the one with the higher ATR.

That's your choice, of course - not an invitation to speculate in the Wall Street Casino.

Average True Range

Sometimes the simplest packages contain some of the finest results. This filter is viable but unless you have a set of fairly sophisticated filtering software you won't be able to duplicate - simply put it tests for the Average True Range less than the Average True Range 20-period simple moving average.

show stocks where close is between 15 and 35
and average volume(90) > 500000
and Average True Range(10) < CMA(average true range(10),20)

The ROI on this filter was 71.30% with a 63% win rate and a spectacular 2.25 risk/reward ratio.

Sometimes just to ensure that it isn't just luck and especially with these simple filters I reverse the premise - for this one I switched the ATR < to ATR > and reran the test.

The ROI was -1.44% with a 56% win ratio and a .98 risk/reward ratio.

Now I don't suggest that you use this filter or anything like it as a selector for your stock picking. What I am saying is if you are looking to invest in a stock then you should probably know where the ATR is in relation to the stock's history.

I write about the INDU ATR in my wraps and it is a fairly good indicator of changes in the near term trend. Currently the ATR is sky high and it shouldn't stay there for long.



You can do this with every stock that you invest in and perhaps give yourself a little extra edge. Remember - ATR is a reasonable proxy for volatility.