BANKNIFTY ATR Trading Strategy

Today in less than 5 minutes:

1) What is a stock’s average true range?
2) Using ATR + Supertrend to identify trends in BANKNIFTY
3) Option Buying vs. Option Selling

Using the Average True Range

Just like a sailor needs to be aware of the strength of currents in the ocean to plan their journey, a trader needs to know the volatility of a stock before they jump in, especially option traders.

One indicator that can help us in measuring volatility is the average true range (ATR).

Derived from the 14-day simple moving average of a series of true range indicators, the average true range shows the average range of stock price swings over a specified period. It is calculated as follows:

ATR = [Previous ATR (n-1) + TR] / n
where n = number of periods, and
TR = true range

Today we’ll be learning to use the ATR for a BANKNIFTY trading strategy ↓

Identifying Trends in BANKNIFTY

Identifying volatility with ATR

The average true range gives a volatility signal.

Simply put, a stock experiencing a high level of volatility has a higher ATR, and a lower ATR indicates lower volatility for the period evaluated.

However, note that the ATR tells us nothing about the potential direction of a stock, it only talks about volatility. Comparing the present ATR with its historical average ATR can tell us a lot about how more or less volatile a stock is relative to its usual historical value.

Identifying direction with Supertrend

We will rely on our favourite Supertrend indicator to identify the trend direction of BANKNIFTY.

The interpretation is straightforward: a green Supertrend signals a bullish sentiment, prompting a long position, whereas a red Supertrend indicates a bearish sentiment, prompting a short position.

But should one buy or sell options, once a view on volatility and direction is formed?

Read on to find out a good way to execute the above view…

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Ask us anything!

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Option Buying vs. Option Selling

Now that we know how to identify a trend and pick a side, i.e. bearish or bullish, let’s learn the best way to execute our view using options. Here’s when to buy or sell options, depending on the ATR movement 👇🏼

When the ATR is going up

A bullish ATR forming higher highs and higher lows indicates rising volatility. This can be best captured with buying options since they rise in value with increasing volatility.

For example, buying a call option would be more profitable if you spot the BANKNIFTY having a bullish Supertrend and bullish ATR, something like this 👇🏼

When the ATR is going down

A bearish ATR forming lower highs and lower lows indicates declining volatility. This can be best captured with selling options, since they rise in value with decreasing volatility, and due to theta decay.

For example, selling a put option would be more profitable if you spot the BANKNIFTY having a bullish Supertrend and bearish ATR, something like this 👇🏼