Understanding True Range (TR)

Hi everyone! Today, I’m excited to talk about True Range (TR), a key concept in technical analysis used to measure volatility in the financial markets. Let's dive into what True Range is, why it’s important, how it works, and how you can use it effectively in your trading strategy.

What is True Range (TR)?

True Range (TR) is a measure of price volatility that takes into account any gaps in price and is often used in calculating other indicators such as the Average True Range (ATR). It is defined as the greatest of the following:

• The difference between the current high and low.
• The absolute difference between the current high and the previous close.
• The absolute difference between the current low and the previous close.

TR provides a more comprehensive view of price movement compared to simply using the difference between the high and low of the day.

Why is True Range (TR) Important?

True Range is important because it helps traders gauge the volatility of a security, which is crucial for determining position size, setting stop-loss levels, and identifying potential breakouts or reversals. It provides insights into the range of price movement, helping traders make informed decisions.

How Does True Range (TR) Work?

True Range (TR) is calculated using the following steps:

1. Calculate the difference between the current high and low: TR1 = High - Low
2. Calculate the absolute difference between the current high and the previous close: TR2 = |High - Previous Close|
3. Calculate the absolute difference between the current low and the previous close: TR3 = |Low - Previous Close|
4. True Range (TR) is the largest of TR1, TR2, or TR3: TR = max(TR1, TR2, TR3)

Interpreting True Range (TR)

Interpreting True Range involves understanding the volatility of a security:

• High TR: Indicates high volatility, with wide price swings.
• Low TR: Indicates low volatility, with narrow price ranges.
• Increasing TR: Indicates increasing volatility, which may precede significant price movements.
• Decreasing TR: Indicates decreasing volatility, which may precede consolidation or range-bound trading.

Practical Example

Imagine I’m analyzing a stock that has been trading in a tight range for several days. Suddenly, I notice a spike in True Range (TR), indicating a surge in volatility. This could signal a potential breakout or breakdown, prompting me to adjust my trading strategy accordingly.

Using True Range (TR) in Trading

Here are some ways I use True Range (TR) in my trading strategy:

• Setting Stop-Loss Levels: I use TR to determine appropriate stop-loss levels based on volatility.
• Position Sizing: I adjust my position size based on TR to account for higher or lower volatility.
• Identifying Breakouts: I look for spikes in TR to identify potential breakout opportunities.

Conclusion

In conclusion, True Range (TR) is a valuable indicator for measuring volatility and assessing price movement in the financial markets. By understanding how to calculate and interpret TR, traders can make more informed decisions about position sizing, stop-loss levels, and trading opportunities. Remember to use True Range (TR) in conjunction with other technical analysis tools for comprehensive market analysis.

Stay tuned for more articles where I’ll explore other essential indicators like the Relative Strength Index (RSI), Bollinger Bands, and many more. Happy trading!