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Using ATR to Adapt To Dynamic Conditions in Forex Market

Using ATR to Adapt To Dynamic Conditions in Forex Market

2014-04-30 20:42:00
Paul Robinson, Strategist
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Talking Points:

  • ATR, an overlooked tool
  • Quickly adapting one’s trading to current market conditions is extremely important
  • Tip for identifying when the trading environment has changed

Volatility, and opportunity along with it, has been declining since the end of January – not exactly what we want to see as traders. But what can we do? The market is the market and we can’t control what it does, however, we can control how we trade it, right? Right. We must adapt, adjust our expectations and tweak strategies accordingly. This means take less out of our winners (and losers, too) as well as be more patient between opportunities. They will come, just in smaller doses. Having had many years of experience trading alongside other professional traders, one thing which always stood out to me was how quickly the best traders were able to adapt to new trading environments. They would go from high gear to low gear and back with relative ease.

What is a good tool for measuring the available opportunity in the market? One gauge traders look at is implied volatility. But what is this? It’s a mathematical calculation which isn’t easily relatable and for comparative purposes we only really understand what is high or low relative to historical. But, what does it mean to us in terms of pips? This is where the use of this simple, yet underappreciated indicator comes in – ATR or Average True Range. I use indicators sparingly, but ATR is one I look at regularly. On a daily chart it measures the average daily trading range over a certain number of days. I generally use a 10-day setting as it is timely enough to be useful, but not overly noisy.

How do I use ATR in my trading?

  • Determine reasonable targets and stops relative to what the market is offering at the time.
  • Look at the direction it is trending and understand that upward means the markets are getting more active, downward is less active.
  • When you start seeing regular daily moves considerably greater than the ATR then it is time to be aware that the trading environment could be changing for the better. When ranges begin regularly falling short of recent ATR readings, it is time to consider adjusting expectations downward.

Below is a graph displaying the average 10-day range of seven key pairs (eurusd, gbpusd, usdjpy, usdchf, usdcad, audusd, nzdusd) – So far, at the peak of 2014 the average daily range (ATR) was 100 pips across these seven pairs. Today, it sits just above 50.

Using ATR to Adapt To Dynamic Conditions in Forex Market

Source: FXCM Marketscope 2.0

In conclusion, if you have been frustrated with the trading activity you’re not alone. But, by adjusting expectations using ATR you will find it easier to handle these inevitable periods of low and declining volatility, ultimately keeping you from making costly mistakes which undermine your profitability. Furthermore, when an uptick in movement begins again, you’ll take notice sooner and be able to take advantage of it longer. Tomorrow, via my blog, I will be discussing why I believe April showers could bring May flowers, seeing some good tradable volatility.

-- Written by Paul Robinson of FXSimplified.com

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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