Average Range vs. Average True Range – Which one is better?
Many traders talk about ATR which stands for Average True Range, but from time to time you see indicators and technical analysis based on the Average Range, AR. So what’s the difference and which one is better?
What is Average Range
The range of a price bar in the chart is the difference between high and low prices of the bar.
The average range is the average of the range of price bar over certain periods.
For example, 5 day average range is the average of the range of the daily bars over 5 trading days.
You can have all sort of combinations, like
– 10 period average range of 15-minute bars
– 50 period average range of 30-minute bars
– 100 period average range of 20-second bars
There is nothing magical with the calculation of the average range. It is a good measure of the price volatility over the period covered by the average. When the average range is rising, you know volatility is increasing, and vice versa.
What is Average True Range
Average True Range is an extended version of average range calculation.
As oppose to taking average of the range of price bars. Average True Range takes the average of the true range of price bars.
What is True Range? True range takes into account the previous price bar information into its calculation when price gaps are involved. Specifically, if a price bar’s range does not close the gap formed from the close of previous bar, then the previous close is used instead of the high/low price that is closest to the gap. Thus, true range is always greater than or equal to the range of a price bar.
Here is an example of daily emini S&P prices (based on 9:30 am – 4:00 pm ET) with the corresponding 10 period average range and average true range values.
Different Tools are Meant for Different Jobs
True range was invented in a period of time that technical trading is more common among commodity trading than in the stock markets. At that time only daily data was available. Gaps is very common in commodities due to their nature being affected by weather forecasts, supply reports, production forecasts, etc. Gaps can easily affect the basic indicators like moving averages, oscillators, etc. By using true range as oppose to just the bar range, the extra volatility caused by the gaps can be systematically incorporated into indicator calculations.
Nowadays, trading has become a real-time business and intraday data is readily available. 24-Hour trading is also getting more common among many trading instruments. In intraday trading, true range plays a much less important role. Sometimes, average true range will magnify the volatility when it is undesirable, for example, in very small time frame like 1-minute data series.
In short, average true range is good for handling data with a lot of price gaps, and the regular average range is more sensitive and better for analyzing intraday data. Each has its own usage and both are good tools.