Average True Value—Knowing the Basics

Commodities are frequently more volatile than stocks. They were are often subject to gaps and limit moves, which occur when a commodity opens up or down its maximum allowed move for the session. As shown in the below chart, @SuburbanDrone has chosen Average True Range (ATR) to represent WTI Crude Oil's volatility.

In this article, we will cover the basics of ATR. (or Realized Volatility used in commodities market).

Chart 1.  WTI Crude Price shown with Realized Volatility (or ATR; Source: @SuburbanDrone)

Average True Range (ATR)

 

Average True Range (ATR) is an indicator that measures volatility.  It was developed by J. Welles Wilder who designed ATR with commodities and daily prices in mind.^[1]

A volatility formula based only on the high-low range would fail to capture volatility from gap or limit moves. Wilder created Average True Range to capture this “missing” volatility.

ATR Values Are Not Comparable

 

ATR is based on the True Range, which uses absolute price changes.^[1]

As such, ATR reflects volatility as absolute level. In other words, ATR is not shown as a percentage of the current close. This means low-priced stocks will have lower ATR values than high price stocks. For example, a $20-30 security will have much lower ATR values than a $200-300 security.

Because of this, ATR values are not comparable.

It is important to remember that ATR does not provide an indication of price direction, just volatility:^[1]

ATR is not a directional indicator like MACD or RSI, but rather a unique volatility indicator that reflects the degree of interest or disinterest in a move. 

Strong moves, in either direction, are often accompanied by large ranges, or large True Ranges. This is especially true at the beginning of a move. Uninspiring moves can be accompanied by relatively narrow ranges. 

As such, ATR can be used to validate the enthusiasm behind a move or breakout. A bullish reversal with an increase in ATR would show strong buying pressure and reinforce the reversal. A bearish support break with an increase in ATR would show strong selling pressure and reinforce the support break. 

References

1. Average True Range (ATR)