ATR to Determine Exits | Volatility Trading Strategies for Beginners | Quantra course
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Welcome to this video about the use of ATR to Determine the Exits. After completing this video, you will be able to describe the significance of the ATR values. And you will also learn to dynamically set your stop-loss and take profit levels, using the ATR indicator. Let's get started!
What do you think the ATR value signifies? For example, here we have the ATR value as 1.32, what can we imply from this number? The ATR value simply tells us the range in which the prices could move in, for the immediate candle that forms. So in this case, we can say that the prices of Colgate-Palmolive are expected to move within a range of 1.32 points from the current close. However, based on this value, we cannot determine the direction in which the prices may move. Thus, the next candle may move in either of the following three ways from the close.
Firstly, the price may move by approximately 1.32 points on the lower side. Secondly, the prices may move by approximately 1.32 points on the higher side. And lastly, the prices could also move in a range of 1.32 points, but in both directions partially.
But enough said about the ATR indicator. How can we put all of this information to good use? You might recollect that in the previous notebook, we built a trading strategy based on the moving average crossover. In the strategy, we also used a fixed percentage to set our exit levels. For example, if our entry price for a long position were to be $100, we would have set our stop loss 1% below the entry price, at $99, and similarly, 1% above the entry price, which is $101 would be our take-profit. A limitation of using the fixed percentage approach is that we do not give any consideration to the ongoing volatility in prices. This means that, as long as the volatility is low, the strategy might be profitable. But as soon as volatility rises, due to the higher fluctuations in prices, it is very likely that our stop-loss orders might get triggered.
So how can we improve this strategy to withstand volatility? If you are thinking about using the ATR indicator, you are headed in the right direction. We can use the ATR indicator to set our stop-loss and take profit levels. The ATR value here tells us that the stock has the potential to move by 1.32 points, either up or down from the close. Thus, we can simply place our stop-loss and take profit levels based on a multiple of the ATR value. The reason why we use a multiple of the ATR value is to leave some additional buffer from this expected range, so as to avoid unnecessary triggering of our exit levels. For example, here we can place the stop-loss at 1.5 times the ATR value, away from our entry price. And similarly, we can place our take-profit at 2 times the ATR value from the entry price. Notice how these exit levels are better suited for the ongoing volatility in the prices, as compared to the fixed percentage approach.
Let's watch how this trade played out. As you can see, the stop loss based on the fixed percentage approach did get triggered, however, the stop-loss set using the ATR value still seems to hold. Moving on, it also seems like we did hit our target. Now let us quickly summarise what we learnt in this video. Firstly, we understood that the ATR value gives us the approximate range in which the prices are expected to move in, for the next candle. And finally, we learnt how to use the ATR indicator to dynamically set our stop loss and take profit levels. The approach is called dynamic, because here our exit levels are placed based on the constantly updated values of the ATR indicator.
That was all for this video.
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