Open Price and the ATR

True Range extends either the High or Low of the next price bar if price opens higher or lower than the previous days close and fails to at least trade to that prior closing price.

For example, if Live Cattle closes on Jan 13th at 74.40, and then on Jan 14th it opens higher and only trades as low as 74.60 for the day, we would use the 74.40 value rather than the 74.60 value as the low for Jan 14th when calculating the True Range for that day. In other words, we would take the High of Jan 14th minus the close of Jan 13th to arrive at the True Range for Jan 14th.

Suppose that Corn closed on Feb 5th at 2.50. On Feb 6th, price opened lower and never traded above 2.44 for the day. When we calculate the True Range of Feb 6th, we would use the close of Feb 5th minus the low of Feb 6th to arrive at the True Range of Feb 6th.

The ATR is a very useful piece of information when dealing with probability. And that is what analysis is all about, determining the probability of whether price will move higher or lower and to decide if and when to enter a trade. With the ATR and the Opening price, we can make another assumption that can prove useful to know.

Many methods rely in part or in whole on the Breakout. This can be a simple trend line breakout of a commonly formed pattern, such as a channel, triangle, flag or what have you. It can also be the point where price exceeds the prior day's high or low, if that price bar proves to be of some significance to the analyst. For example, as a Technical Analyst that specializes in calculating Turning points in time (in advance), often I will enter a trade off the low of a price bar that I have earlier calculated is likely to form a swing top. This allows me to only enter the trade short if indeed a swing top materializes...and not a moment earlier. Or vice-versa, I may enter long just off a price bar's high, if I suspect that the low of that price bar is likely to become a swing bottom.

There are times when you are filled from a breakout, only to find that the market does not close that day in profit territory for your trade. You must wait out another day to see if price will move in your favor, or was only interested in filling your order than going the other way instead. The opportunity to move your stop-loss to breakeven never manifested itself. Getting your stop-loss to breakeven as quickly as possible is a very wise goal for a trader to have. It must be done at a point where it is not likely you will be stopped out prematurely and be able to allow the market to move without hitting your stop-loss price. For once you can successfully get that stop-loss to breakeven or better, it provides you a great amount of latitude in managing the trade from there.

One of the things I have noticed from my study of price action is the relationship between the Opening price and the ATR.

For instance, suppose you are planning to Sell just below the prior day's low in expectation of prices moving lower for a few days. You notice that the ATR in Soybeans for the last 10 days is 7 cents (using True Range for the ATR). The prior day's low is at 540, so you want to sell if price reaches 539 3/4.

The market OPENS at 545 1/2. That is 5 1/2 above the low of the prior day, and 5 3/4 above where you want to Sell. Noting that the ATR is around 7 cents, the Probability is very high that if you were to be filled that day, price would not move much below your entry price and will also likely close at or above it. You would expect to very likely be in a trade that did not immediately move into profit and close, requiring you to await the open of the next day with all the surprise that comes with opens.

On the other hand, if the market OPENS at 541 1/4 for instance, and when price starts moving towards your entry price you note that the highest it traded after the open was to 543, then you can figure that the Probability is high that if you are filled, price is likely to move into profit territory. This assumption is based on the high of 543 minus the ATR of 7 cents to arrive at a possible low for the day around 536 or so. Probability is simply higher than price would be at breakeven or profit when the market opens closer to the entry price you have chosen, rather than if it opened far beyond it by the ATR.

Keeping an eye on the ATR and where price opens in respects to where you are planning to enter can help in determining the Probability of whether a fill could see a close in profit or not. Knowing this can help you plan your exit strategy, a subject beyond the scope of this article.

Note: About the Author
Rick J. Ratchford is President of ProfitMax Trading Inc. He is a full-time commodity trader for his own account as well as assisting other traders. He has been a computer programmer for more than 20 years and a trader since 1990.