Average True Range Stop

Average True Range (ATR) is a measure of volatility and market noise introduced by Welles Wilder in his book: New Concepts in Technical Trading Systems. It’s an indicator of the tendency of a security to move, in either direction.

More specifically, the average true range is the (moving) average of the true range for a given period. The true range is the greatest of the following:
• The difference between the current high and the current low
• The difference between the current high and the previous close
• The difference between the current low and the previous close

The value returned by the average true range is simply an indication as to how much a stock has moved either up or down on average over the defined period. High values indicate that prices are changing a large amount during the day. Low values indicate that prices are staying relatively constant. ATR does not indicate a trending or ranging market.

Once the ATR is calculated, a multiple of this value can be deducted from your entry price and used as stop loss. Examples of this multiple for a stop are usually 2xATR and 3xATR depending on your trading method and risk. The greater the number of ATRs, the wider your stop, and the more willing you are to let prices swing before declaring a change in trend.

Example
Entry $2.00 with ATR of $0.10 (stop loss at 2xATR would be $1.80)

Once entering using this method your stop loss should never be moved down. It should either remain at the current level, or move up with the ATR and price action.

Example
Entry $2.00 with ATR of $0.10 (stop loss at 2xATR would be $1.80)
Current Price 1.90 with ATR of $0.09 (stop loss at 2xATR would remain at $1.80)
Current Price 2.10 with ATR of $0.12 (stop loss at 2xATR move up to at $1.86)