Average True Range (ATR) and Sizing a Stop From It

You buy a stock at $50 and want a stop. At $49, a normal afternoon wobble can take you out before the trade has done anything, and at $40 a loss, if it comes, will be far larger than you planned for when you sized the position. The right distance depends on the stock. ATR is how you measure it.

True range, one bar at a time

A bar’s high minus its low misses the gaps. If a stock closes at $49 and opens the next morning at $51, that two-dollar jump happened, and a stop sitting at $50 would have been skipped over. True range fixes that by checking the prior close too. It takes whichever of three distances is largest: the high minus the low, the distance from the high back to the prior close, and the distance from the low back to the prior close, each taken as a positive number.

Bar 2 gapped up. Bar 3 gapped down. High minus low alone would have understated the movement by more than a fifth.

Smoothing over 14 bars

The standard setting of 14 periods comes from Welles Wilder, who introduced the indicator. His method starts with a simple average of the first 14 true ranges. Each later ATR is mostly the old value. The latest bar adds one part in fourteen.

One wide bar nudges ATR. It takes a run of them to move it much. Some charting tools use a plain moving average of true range or an exponential one, and the numbers come out slightly different, which matters little for placing a stop but can confuse you when two platforms disagree by a few cents. Most charts default to daily bars. Switch to weekly or hourly bars and the ATR changes timescale with them.

From ATR to a stop and a share count

Traders commonly set a stop at a multiple of ATR below the entry, often somewhere between one and three, so the stop sits beyond the stock’s ordinary range. Then they work backward to the share count. Hitting the stop should cost a fixed dollar amount.

A calmer stock gets a bigger position. A jumpy one gets a smaller one. Either way the trade risks $500, provided the stop fills where you set it. The position size calculator runs the same sum for any entry and stop. Gaps through a stop can still produce a larger loss, which is why sizing around known events, covered in the economic calendar and position size, deserves separate thought.

A variant trails the stop. Each day it sits a set number of ATRs below the highest close since entry, so it rises with the trade and never moves down, and because the share count shrinks as the multiple grows, the dollar risk stays the same whichever multiple you pick. Wider multiples give a trend more room. They also let more of the gain slip away before the exit.

Comparing stocks: ATR as a percent of price

ATR is in dollars. On its own it can’t compare a $20 stock with a $200 one. Divide by price.

Stock B has half the dollar ATR. Its relative movement is two and a half times larger. Some screeners offer ATR percent as its own field, and many only give the dollar figure, so do the division yourself before sorting a list by it. On quote pages ATR rarely sits in the main summary at all; it lives in the charting panel as an indicator you add yourself, where you pick the period and the bar length, and the default period there is almost always 14.

What ATR does not tell you

It has no direction. A stock falling steadily and one rising steadily can post the same ATR. It also looks backward, so a quiet stock heading into an earnings report will show a small ATR right up to the morning the range explodes, and a stop sized on that calm reading can be far too tight for the one day that matters. It ignores the market too. How a stock’s moves line up with the index is what beta measures. For a year’s view of where the stock has traded, check its 52-week high and low.

ATR works best as a yardstick for distance. Use it to set the stop and the share count. Whether to buy at all is a question for other tools.