How to use ATR for stock selection, trailing stop-loss and profit booking?
Profit booking is the most significant part of short-term trading. We make a profit or loss not on our entries but on our exits.
ATR: FOR STOCK SELECTION
The nature of volatility is cyclical, it rises and falls. It moves from a period of low volatility to high volatility, and vice versa. This means that when the market is in a low volatility period, we can expect volatility to pick up soon. By using this concept, we can find some explosive breakout trades before the breakout actually happens.
In the intraday chart of Havells India Ltd given above, the stock is trading in a narrow range for two days. The volatility is getting squeezed and the ATR has reached near the recent low. Thereafter, we witnessed an explosive breakout in price.
ATR: FOR PROFIT-BOOKING
Profit booking is the most significant part of short-term trading. We make a profit or loss not on our entries but on our exits.
For profit-booking, ATR works like a fuel indicator in a car. The fuel indicator in the car tells us how much fuel is left in our car. If we know the average kilometre the car travels per litre, we can figure out how far we can travel without running out of fuel. Similarly, the ATR helps us to understand the profit potential of our trade.
Daily ATR (DATR) gives us an average daily range of that particular stock. By using DATR, we can easily calculate the profit booking levels. ATR tells us exactly how much we can expect the price to move on any given day based on the recent price movement.
For example, on February 6, 2019, Nifty gave a range breakout at 10,980, and after the breakout, the price moved higher as expected. Now, we have to check the intraday upside potential of Nifty, so we added ATR (14) in the low of that candle, which will help us to identify the potential target for that day.
121.15 (ATR) +10,964.40 (low of candle) = 11,085.55
On that day, Nifty made a high of 11,072, which is near the ATR target.
ATR: AS VOLATILITY-BASED STOP-LOSS OR TRAILING STOP-LOSS
Many traders use normal support levels defined by a demand zone to set up stop losses. However, in this method, many traders ignore the speed of volatility. Hence, using ATR to set up stop losses is the way that professional and algorithmic traders follow.