Using the Average True Range (ATR) Indicator for Exiting Trades
If you get frustrated by a winning trade turning into a loser, or getting out of a winning trade only to have it continue moving in your favor for an even bigger gain, a trailing stop loss may help. While there is no perfect solution in the trading world—we will hardly ever exit a trade at exactly the perfect time—at least a trailing stop loss can help keep us in a trade while it’s working and get us out when it isn’t.
What is the Average True Range (ATR)?
One of my favorite trailing stop loss techniques it is to apply an Average True Range Stops, or ATR Stops, indicator to my chart. Not only does it help identify trend direction, but it is also useful for signaling when to get out of a trade.
True range is how much the price moves within a price bar/candle. Average true range (ATR) is an average of how much the price is moving on each bar. I use a 6-period average for my ATR Stops indicator, although you may find something else works better for you. The ATR then has a multiplier applied to it, such as 2, 2.5, or 3. When the price is moving up, the ATR Stops will be the ATR x multiplier below the price. When the price is moving down, the ATR Stops will be the ATR x multiplier above the price.
The following chart shows a 6-period ATR Stops with a 3 multiplier on Apple (AAPL) stock.
The multiplier determines how tight the indicator is to the price. A larger multiplier is better for someone holding longer-term trades, while a smaller multiplier is better for someone who wants to get in and out more often, or only wants to ride one price wave and then get out as soon as a significant move in the opposite direction occurs.
Setting the Multiplier
Before each trade, I determine the best settings for the trade I am taking. I do this by adjusting the ATR Stops multiplier to match what the stock has done in the past. Some stocks are more volatile and tend to whipsaw across the indicator. In this case, a bigger multiplier may be needed. If the stock moves smoothly, a lower multiplier will likely work better.
Since I am a trend trader, and typically only get involved when a strong trend is in play, I don’t care if the price whipsaws across the indicator while the price action is choppy. This will happen. I just want the indicator to track the price nicely when it is trending. Not too close that it gets touched on tiny price moves in the opposite direction, but also not so far that the price has to move a whole bunch just to reach the indicator.
On the following charts, the top one has a 3x multiplier, while the bottom has a 2x multiplier. The 3x gives the price a bit more room, while the 2x times tracks it closer. On the decline from May to August 2018, the 2x would have gotten a trader out earlier than the 3x. But that isn’t always so bad. During the rally at the start of 2019, the 2x would have alerted the trader to get out before the 3x did.
Two Ways to Use It For Exits
When it comes to exits, I use two methods. I determine before each trade which one I will use.
- Exit when the price touches the indicator line. For example, get out of a long trade when the price drops below the rising ATR Stops.
- Exit only when the price CLOSES below the ATR Stops on a long trade, or CLOSES above the ATR Stops on a short trade. Once the close occurs, place a stop loss a few cents below the low of that candle for a long trade, or a few cents above the high of that candle for a short trade.
Both methods have their advantages and disadvantages. As mentioned, we don’t have perfection in trading very often. But what we can have is a method that gets us out of trades when they start working against us, and that lets our winning trades run. Those are both keys to successful trading.
By Cory Mitchell
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