This article is continuation of previous one about Average True Range: ATR – Useful Indicator In Daily Trading
Setting a stop loss
Stop losses are usually set using observation of a chart and a simple trend reversal technique.
Since this is widespread practice there is no mystique and every market participant can expect to find stops at a certain level.
Using an ATR can be a useful way of confounding such methods and provide additional security. Setting a stop loss at, say, three times the ATR we can be sure that we are wrong it our view of the market and not getting whipsawed by big players. Furthermore, it enables the traders to “hide” his stop.
As an indicator of a breakout
A particularly narrow ATR illustrates consolidation and is a signal that a breakout is coming.
This indicator cannot be used to open positions since it only warns of a breakout, not its direction. It can be useful as confirmation relating to another signal.
Larger than normal ATR Indicates extremes
An ATR exit below the last high or low is a significant signal. This suggests that the market has reached a pivot point. Observation is a useful addition as signals and indicators don’t always convey the message we expect.