E-mini Trading: The Average True Range And Price Volatility

There are periods of time in the market when it seems that every e-mini trade you initiate works in the right direction and trading is a dream job. On the other hand, there are also times in the market that every trade e-mini trades works erratically, the price moves in an unexpected way, and new traders are introduced to price spikes and high market volatility.

For longer term traders, the CBOEs Volatility Index (VIX) can be helpful because it measures implied volatility over the next 30 days. I suppose that it is helpful to keep an eye on the VIX, though you really dont need an indicator to realize the market is very volatile. We can agree that the VIX has some limited application in intraday e-mini trading.

But there is a problem here

The VIX has a longer trading horizon than the average e-mini scalper. No, we need to find something that is a little bit more focused on the near term. Fortunately, J. Welles Wilder introduced the Average True Range (ATR) indicator in his highly regarded book, New Strategies in Trading Systems in 1978. The ATR is a technical indicator designed to measure the volatility of the market over a user-determined time period. The formula is relatively simple, from a math perspective.

In this example, the equation compares the daily and previous day lows to determine short term volatility:

True Range= max(high, close[prev]) min(low, close[prev])

On most trading platforms, the default time period is 14, and this seems to work pretty well. The 14 is the number of specified time periods under consideration; these time periods may be seconds, minutes, hours; traders use a wide variety of formulations with the ATR. For our purposes, we will set the chart to 3 minute intervals and the ATR to 14. Lets also assume we are going to be trading the YM contract.

After 2 hours of trading, the ATR is 36. What does this number tell us? It is telling us that every 3 minute period, the range of the bar has been ranging 36 points. Wow! The ATR gives you information about the short term volatility. A number like 36 tells us that the market is very volatile and we, as small traders, should probably wait for a period of time when the ATR is nearer to our preferred stop/loss number. To understand this, imagine taking a trade and setting your stop loss at 10 when the ATR is 36. Barring great luck, the most likely outcome will be the trade being stopped out.

I would also point out that the ATR is not a primary indicator for trading, but is a barometer for where you might:

Pick a logical stop/loss target
Establish a trading zone where you will take profits
Help a trader determine the relative risk of any given trade from a volatility standpoint.

In summary, we have pointed out some characteristics of the VIX and ATR, and suggested appropriate uses for these tools. We have also discussed some applications for the ATR in more detail and emphasized that the ATR is not a primary indicator in trading.