Calculating risk is an important part of determining how to buy stocks, and the average true range can help make portfolio management decisions easier for investors.
Finding the average true range, or ATR, of a stock is a long-standing way of measuring how much a stock's price travels during a normal day. This helps investors calculate how risky a stock can be.
The average true range for a stock can be found by first taking the difference between the day's high and low, then dividing that by the prior session's closing price. Then, an average move of a stock can be calculated over a variety of time frames.
The Investor's Business Daily team looks at a stock's 21-day ATR in percentage terms to get a better sense of a stock's typical movements over the previous few weeks.
Audio Version Of Podcast
Accounting For Risk With Average True Range
Converting a stock's ATR into a percentage makes the metric comparable between stocks. For example, consider a 5-dollar average true range on a stock worth 500 vs. a 5-dollar average true range on a stock worth 50.
IBD's MarketSurge charting platform can express the average true range as a percent, which Mike Webster, senior market strategist at IBD, says he prefers.
To view the preferred 21-day average true range on MarketSurge, tap the wrench icon on the lower right hand corner. Select "Customize Column Layout" from the menu. The column is listed under "Price & Volume" and also includes options for a 30-day and 50-day ATR percentage.
Webster says using the percentage value can help determine how to buy stocks, manage risk and assess the personality of potential investments.
"When you're comparing a 7% move on a slow, pokey stock that maybe trades on average 2% a day on its range, vs. something that trades 10% or 15% on average, that 7% is totally different," he told IBD's "Investing with IBD" podcast.
Check out this week's podcast episode for more details on how to use a stock's average true range in your trading.
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