How to use ATR for intraday Bank Nifty option trading?
Kannan
Average True Range (ATR) indicator, as the name suggests, is a metric that gives us the average move of a security for a particular period. The important thing to understand about ATR is that it is neither a leading indicator nor an indicator that tells us the trend.
ATR lets us know how volatile a security has been over a particular period and this indicator helps in sensing the strength of the existing trend. ATR increases when the security makes relatively larger moves and vice versa. Hence, we can assume that if ATR increases when the security moves in a direction, the prevailing trend is strong and that it is most likely to continue. But if the ATR starts falling, it can be taken as an indication of a loss in momentum of the trend.
Now coming to your question, ATR can generally be used to find the possible extremes of movement for a period. For instance, on October 12, Bank Nifty closed at 44,599 and the 14-ATR on the daily chart stood at around 440, which means, the index has been moving 440 points a day on an average recently.
Hence, approximating Bank Nifty’s close to 44,600, the potential limit on the upside and the downside for the index on Friday would be 45,040 and 44,160 respectively. In other words, 45,040 can be a strong resistance and 44,160 can be a strong support and a move beyond these levels is less likely for intraday. Bank Nifty closed at 44,288 on Friday after marking an intraday low of 44,204.
Commonly, breakouts in 14-ATR in a 15-minute chart are used to take intraday trades. For example, Bank Nifty started falling on September 18. On September 21, the 14-ATR in 15-minute chart saw a breakout as it moved above 115 when the index was around 44,800. Here, the index was falling, and ATR went up, an indication of a strong bear trend. Post this, Bank Nifty fell to mark a low of 43,857 on October 4. Buying put options would have been a profitable strategy.
We reiterate that ATR is not a trend-identifying tool but gives us the volatility and trend strength. But note that it can be effectively used for placing stop-loss. For instance, if you initiate short-term long positions, you can place stop-loss at a price that is two times ATR lower from the current market price. While 2 is the thumb rule, 1.5 times daily ATR is also very common. For high-beta stocks, 2-ATR can be used and for low-beta stocks, 1.5-ATR would be sufficient.
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