Volatility Analysis
Figure 21.23, a consolidation is tested by price on numerous occasions. The trader
is only interested in the volatility that surrounds the immediate area of reaction
with the support and resistance levels. The trader may select a short lookback pe-
riod for the ATR in order to identify the locational volatility at support and resis-
tance. Let us assume that the trader chose a five‐period lookback in this example.
The trader may either look for the highest corresponding ATR value associated
with Points 1 to 4, or just chose the highest ATR value if the range of ATR values
is fairly close. The average ATR in this case would be approximately (10 + 5 + 4
+ 5)/4 = 6 pips, and the highest would be 10 pips. The trader now must decide
on what multiple of ATR to apply to the average or highest ATR value obtained
from the analysis. Assuming that the trader uses 2 × ATR = 2 × 6 = 12 pips as the
stopsize, this would have been an effective filter at Point X where the maximum
adverse price excursion from the breakout was only 6 pips.
Figure 21.24 is an example of using a 2‐sigma threshold level over a speci-
fied number of periods as a filter for selecting an ATR value to size a stop. As
before, the trader may opt to size the stop using some multiple of either the
average of the most significant ATR values that exceed the upper 2‐sigma band
or simply choose the highest value if it is not too large as compared to the rest
of the ATR values. Assuming that the trader uses 2 multiples of the highest ATR
value, that is, 2 × 15 pips = 30 pips, that would have acted as an effective stop
for the subsequent trendline breakout, which had a maximum price excursion
of approximately 25 pips.
In short, the ATR may be used as a volatility gauge of price fluctuations. Simi-
lar durations with larger ATR values are considered more volatile with respect to
the third measure of volatility.figure 21.23 Using Location Centric ATR to Size a Stop on the 5‐Min EURUSD
Chart.
Source: MetaTrader 4