This is the third article in our ATR series. If you haven’t already, we suggest that you check out the first article about the ATR Indicator. In the previous two articles, we have covered the background, the calculations involved, and how to use and read the ATR indicator. Traders rarely use the indicator to discern future price movement directions, but use it to gain a perception of what recent historical volatility is in order to prepare an execution plan for trading.
Forex traders focus on the ATR key points of reference, which are highpoints, lowpoints, or extended periods of low values. As with any technical indicator, an ATR chart will never be 100% correct in the signals that it presents, but the signals are consistent enough to give a forex trader an “edge”. Skill in interpreting and understanding ATR signals must be developed over time. In the example below, let’s develop a simple trading system based on ATR signals and alerts.
The following trading system is for educational purposes only. Technical analysis takes previous pricing behavior and attempts to forecast future prices, but, as we have all heard before, past results are no guarantee of future performance. With that disclaimer in mind, the “green” circles on the above chart illustrate optimal entry and exit points, and the “green” ovals indicate a breakout or reversal is imminent using ATR analysis in combination with the RSI “blue” indicator line.
A simple trading system would then be:
- Determine your entry point when the “blue” RSI line dips below the “30” lower limit line and add 25 “pips” (“1.5X” the ATR value shown);
- Execute a “Buy Limit” order for no more than 2% to 3% of your account;
- Place a stop-loss order at 25 “pips” (“1.5X” the ATR value shown) below your entry point;
- Determine your exit point when the RSI crosses the “70” upper limit line and is accompanied by a declining ATR value from a previous peak.
Steps “2” and “3” represent prudent risk and money management principles that should be employed. This simple trading system would have yielded a profitable trade of 100 “pips”, but do remember that the past is no guarantee for the future. However, consistency is your objective, and hopefully, over time, ATR Technical Analysis will provide you with an “edge”.
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