Position Sizing - ATR Method

Average True Range (ATR) is a technical indicator to measure price volatility. This indicator is first indtroduced by Welles Wilder.

In simple words, when the market shows a trend (either up or downtrend), the ATR tends to be higher. The opposite works: when the market goes sideways, the ATR tends to be lower. It is indeed shows you price volatility.

So, how can you use it to calculate your position sizing or how many share you will buy?

Example:
Let assume:
Your initial capital (C) is $100,000.
Your risk (R) of losing in a single trade to your C is 0.5%.

Stock A has ATR of 75 cents over the last 20 days and that you are prepared to risk $500 on this particular trade (ie 0.5% of $100,000). By dividing 75 cents into $500, this would calculate the number of shares that you could buy, based on intrinsic volatility. Most traders using this method decide to use 2xATR ie 0.75 x 2 = $1.50 to position size. For example, $500/$1.50 = 333 shares can be purchased.

To read about another way to size you position.