How to Gauge Stock Volatility Using Average True Range - dummies

How to Gauge Stock Volatility Using Average True Range

Most day traders prefer volatile securities, because that creates more opportunities to make a profit in a short time. The volatility of a stock, bond, or commodity is a measure of how much that security tends to go up or down in a given time period. The more volatile the security, the more the price fluctuates.

But volatility can make gauging market sentiment tougher. If a security is volatile, the mood can change quickly. What looked like a profit opportunity at the market open may be gone by lunchtime — and back again before the close.

The average true range is a measure of volatility that’s commonly used in commodity markets, but some stock traders use it, too. It’s a measure of how much volatility occurred each day. When averaged over time, this measure shows how much volatility takes place during the period in question. The higher the average true range is, the more volatile a security is.

Many quotation systems calculate the average true range automatically, but if you want to do it yourself, start with finding each day’s true range, which is the greatest of

  • The current high less the current low

  • The absolute value of the current high less the previous close

  • The absolute value of the current low less the previous close

Calculate those three numbers and then average the highest of them with the true range for the past 14 days.

Each day’s true range number shows you just how much the security swung between the high and the low or how much the high or the low that day varied from the previous day’s close.