Hi guys, My second participation for the week and I will be joining lessons presented by prof @kouba01 on "Crypto Trading With Average True Range (ATR) Indicator".
1- Discuss your understanding of the ATR indicator and how it is calculated? Give a clear example of calculation
The Average True Range (ATR) Indicator
Each time range is discussed in the cryptocurrency space, it primarily denotes the movement of market price over a given period taking into cognizance the volatility. Therefore the Average True Range Indicator is that Volatility indicator that measures the average movement of an asset during a given period. These movements observed by this indicator can be more frequent or less frequent which determines how volatile or less volatile a given market is seen at that point.
The Average True Range indicator provides traders especially beginners on how best to engage the trade by providing Trend Reversal as well Overbought and Oversold scenarios of price movements. Therefore, traders can now make informed trade positions while Opening or Closing Trades. This is relative to the presence of the Stop-loss and Take Profit tool available to the trader who ordinarily may not have the willpower to monitor trades over a longer period.
Since we cannot really determine the behavior of market action due to the activities of buy & sell in trade which have effects on demand and supply, therefore the ATR indicator would give us more non-false signals when volatility is low rather than when it is high. Therefore there is more likelihood of having false signals during periods where we have high volatility, hence traders should be guided in making trade positions.
How Average True Range is Calculated
When the Average True Range Indicator is observed to oscillate up and down, there is a corresponding price movement in his regard which also be observed in divergence. A new ATR is usually observed to be calculated at the end of each period. For instance, A new ATR is calculated for a 5 minutes chart after every 5 minutes, likewise after 24 hours for a 24H chart.
In calculating the ATR manually, the user will have to calculate the series of these True values with the period under review and the True Range is the greatest value amongst the values calculated or the Average of all the True ranges calculated for ATR which is;
1- Current Low Price - Previous Close Price
2- Current High price - Previous Close Price
3- Current High Price-Current Low Price
The default settings of the ATR are 14 periods but adjustments based on user preference. In calculating the TR, its positive or negative value does not matter rather the greatest value is used. The formula below is also another simpler way of calculating the ATR.
Current ATR = [(Prior ATR *13) + Current TR]/14
For example, if the Prior ATR for a 14 period is calculated to be 6.5 and the True Range is 5.5, the current ATR;
Cuurent ATR = [(6.5*13) + 5.5]/14
= (84.5 + 5.5)/14
Current ATR = 6.43
This simply shows relatively low volatility which represents a low ATR calculated.
2- What do you think is the best setting of the ATR indicator period?
The default settings observed in the Average True Range is the 14 Periods which simply means that a new True Range is created after the 14 day period elapses. Therefore, the best settings obtainable from this indicator should be sole;y dependent on the trader or users at that given time. If the readings generated from it are able to give or maximize trade positions, it goes for the selected period.
But in my own understanding of the Average True Range, the longer the periods the smoother the results unlike what is obtainable in the short period's settings on the indicator. Short periods are observed t give faster readings/results and hence prone to false signals which may be detrimental to traders' position in the market whereas the longer periods are smoother and more ideal for use.
3- How to read the ATR indicator? And is it better to read it alone or with other tools? If so, show the importance. (Screenshot required)
How to read the ATR indicator
Reading the ATR is a much easier one that beginners can also do from a chart. Since it is observed to measure market volatility at any given period. High market Volatility accompanied with the later formation of candlesticks are observed to have higher corresponding ATR values. This is also applicable with lower volatility with corresponding low ATR values.
From the screenshots, we can vividly see that the bearish high volatility with large candlesticks was accompanied by the corresponding high ATR values. Moreso, Each time we see an increasing value of ATR value, there is always a corresponding high Volatility in the market.
Combining ATR indicator with other Tools
There is no 100% perfect indicator or stand-alone indicator that is observed to be efficient end effective if not combined with other tools/Indicators. Indicators are known to be more effective/efficient when combined today.
Just as we were taught from the lessons that the ATR indicator is best combined with the Parabolic Sar, I will be combining this indicator with the RSI indicator which is a momentum Indicator.
The RSI Indicator is a momentum indicator that guides traders on how best to make trade positions using its signals from the Oversouht and Oversold readings. When price movements are observed approaching the bands 30 RSI line and then crosses, the asset price is in its low level or in oversold levels. This scenario is also observed when price movement is seen approaching the bands 70 RSI line and hence crosses this point which places asset price in an overbought level.
Both scenarios all happening in the Overbought and Oversold regions are possible levels to anticipate trend reversals. At bands 70% asset is at its peak with possible bearish reversals and at bands 30% asset is at its low level with an anticipated bullish reversal.
From the chart above, on the 10th Nov 2021, assets price was observed to be at bands 20% signifying an oversold position. We can also observe that in this scenario, we expect that there should be a trend reversal which was anticipated and also occurred. We can also see a corresponding increasing value of the ATR which signifies that there was high bearish volatility which dragged down the price of assets to the oversold region.
4- How to know the price volatility and how one can determine the dominant price force using the ATR indicator? (Screenshot required)
How to know the price volatility
There is always an observed correlation between the asset price volatility and the ATR indicator values. Each time we see stronger price volatility in price movement relative to the formation of larger body candlestick, there is usually a quantum leap pf the values of the ATR indicator.
From the Screenshot above Box A and B increased volatility both in the Bullish and Bearish movement respectively which also corresponded with the ATR indicator line which was observed to increase in value. At point Box, A price increased from 65.9K to 68.7K due to market volatility, and hence a bullish trend was observed, wherein Box B, the price decreased steeply from the latter level to 62.6K which also showed increased values of the ATR. Though these increases happened in different scenarios (Bullish and Bearish), values of ATR a=were observed to increase in a corresponding value.
But from Box C & D we saw relatively low price volatility as the ATR indicator was observed to also be decreased in its values. Fors Boxes E and F, we have the same scenarios as observed in boxes A & B where an increase and decrease in price action comes with a commensurate increase in value for the ATR.
How to determine the dominant price force
We all know that the price volatility on a chart should be able to correspond with the ATR indicator in order to ascertain the dominant price force. That is to say, bullish or bearish trends should be observed to come with spikes in the ATR value to determine the dominant price force.
From there chart above, we can always see a market correction or reversals with the ATR indicator as soon as the trend has finished its spike. In Point A, we can observe that price action was on the bullish trend but the ATR indicator was showing a reversal signal showing that there was not enough buying pressure to sustain this which thereafter we observed that trend action corresponded with the ATR indicator line in the bearish trend which represents the bearish trends of price movement. This scenario was also found in point C with the same use case. This all showed that the ATR indicator line and Price action do not correspond to the Dominant price force.
But from Point B and D, we can see the ATR indicator line corresponding with the price trends which shows high trends. When there is high price volatility as seen in boxes B & D there should be corresponding spikes in the ATR values as demonstrated.
5- How to use the ATR indicator to manage trading risk ?(screenshot required)
In cryptocurrency trading which is the context of these lessons, risk management is essential given to the volatility traders face on a daily turn. It is important that there are laid down guidelines that ensure traders' prospects of managing their assets at any given time. Knowing the risk aversion which entails that every trader should have a limit in which they can let go of their assets when the market goes against their favor.
Just after we know that the two important positions a trader should take are the ENTRY and EXIT strategies, this brings us to the tool of applying the STOP LOSS & TAKE PROFIT in our trade so as to guard against unprecedented market losses as well maximize profits once it goes in our favor. Therefore the ATR indicator is an important tool that also aids in the RISK management of traders' assets in the market terrain.
The Stop Loss Tool
The Stop Loss tool happens to be a show stopper when the market goes contrary to one set strategy in trade. It is important we know our Risk Tolerance Level to also help know what level of aversion we can withstand at a given time or period. This tool should not be placed in such a manner that it triggers off easily so as to give room for short-term
trend reversals as well not to be too wild enough to lose percentage values we cannot tolerate.
So this is an exit strategy that gives every trader a leverage point to exit the market especially when trade isn't in our favor or experiencing high market volatility. In the ATR indicator, it gives us a formula that helps us place this tool appropriately.
Stol Loss: Entry Price +/- 3 x ATR Value
For instance, if need to make an entry position in the BTC/USDT pair when the price is at $59,760 with my ATR value of 900. In using the formal;
Stop Loss: $59,760 + (3 x 900)
Stop Loss: $62,460
This simply entails that I will represent this value in my chart should in case bring corrects itself and invalidates open position, hence a new entry position is set up.
The Take Profit Tool
Just like the scenario we have in the Stop Loss tool, the Take profit is the opposite of this use case. This is a situation where we feel that the market is in our favor but nevertheless, a good Take profit strategy should be set up so as to know when exactly to exit the market hence maximizing trade positions.
From the chart, I will also have to maintain a Risk: Reward ratio of 1:1 so as to be in the safe zone. Since the Entry Price point is $59,760, and ATR value still at 900, in applying the formula;
Take profit: $59,760 - 2700
Take profit: $57,060
6- How does this indicator allow us to highlight the strength of a trend and identify any signs of change in the trend itself? (Screenshot required)
The Strength of a Trend
We already know that the ATR indicator cannot b used to determine the direction of trends rather its strength at a given period can be observed. Therefore with Price movement, the ATR Indicator can be more useful in letting us know the trend's strength. Primarily, the strength of trends is dependent on the forces of demand and supply inherent in the market behavior of traders as they carry out their buy/sell activities.
Resistant and support levels may be crossed depending on Trends strength as well as anticipated trends reversals. So as we expect market volatility in trade relative to price actions, trends are expected to gain strength in forming new candlesticks, attending Higher Highs/Lows or Lower Lows/Highs.
From the chart above we can clearly observe that the price trend broken through the Resistance level with large candlesticks showing more buying pressure as well a corresponding increased ATR value.
Another signal from the chart is the incidences of tren reversal which usually anticipated market correction after trend exhaustion. MArket DOmninant price force must have been observed in a scenario whereby high price volatility is accompanied with a corresponding high ATR value which thereafter there loses its high volatility and hence possible trend reversal in opposite direction.
From the chart above we can observe that market was in range it sideways movement with a relatively low ATR value hence the decreasing ATR line indicator observed. This also shows that the required Dominant price force is low that is required to keep the trend in its direction, hence the trend exhaustion or weak selling pressure. Thereafter we saw that the ATR value started increasing as price action maintains an upward movement in the opposite direction of the previous trend. This trend reversal comes with the dominant price force where price action and ATR value are directly correlating.
7- List the advantages and disadvantages of this indicator
Advantages of the ATR Indicator
- Unlike the other technical indicators in use, the ATR indicator is a simple and easy-to-use indicator for all categories or levels. That is, Novice/Beginner can use this indicator.
- It gives a clearer picture of trends through the price volatility corresponding to price action
- Users of this indicator can rest assured of their risk management strategy as this strategy consciously put in place the Takeprofit and Stop loss tools to maximize profits as well minimize losses in a trade
- Flexibility when in use as it can be combined with other indicators for efficiency and effectiveness as well for any time frame.
Disadvantages of the ATR Indicator
- Does not give direct buy and sell signals to users but rather only helps manage the risk in trade when positions are opened in trade.
- For the effectiveness of this indicator, users must have to combine other indicators to get its efficiency and application in any given trade. Users are discouraged to use indicators as a standalone indicator at any point.
No doubt every indicator has its drawbacks and when they are created to serve a purpose, they end up bringing up other limitations. No indicator is 100% efficient instead they are maximix=zed when combined with other indicators for accuracy and efficiency of use. The ATR isn't an exception as it parades itself strongly in determining the market volatility at a given timeframe. It brought about a modest way geared towards risk management of trade assets given to its Stop Loss and Take Profit tools.
Thank you Professor @kouba01 for your lessons.
Note: All screenshots used for this task are from the Tradingview site.