Generally, traders tend to use the Average True Range (ATR) indicator as a secondary tool. However, the current low levels of the 14 day ATR have occurred three times previously over the last two years, and on each occasion the market sold off significantly. While the fundamentals around Australian shares remain positive, traders and investors may treat this a short term market warning.
The ATR is a volatility measure. It looks at the variation between previous prices and today's high and low, capturing intraday movements that are excluded from the calculation of Historical Volatility. Many traders use ATR once their trading plan has given a buy or sell signal, using it to set entry and exit levels, and especially stop loss orders.
Here's the daily chart with ATR at the bottom:
Australia 200 Index - Daily
Source: CMC Tracker
The black arrows mark the lows on the ATR - in each case, a reading of just over 42 points. In each case, the low saw the start of a sell-off.
There are several reasons to be cautious about this "signal". First, past performance is not necessarily a guide to future performance. Secondly, volatility theories mean that while a sharp move may be coming, it doesn't predict the direction of the move.
Further, the fundamental explanation of this signal is somewhat fuzzy. It's most often made about the US Volatility Index (the VIX). The theory suggests that low volatilities are a sign of investor complacency. This can lead to a sudden, sharp realisation of risks, sparking a sell off.
Regardless, this is a warning on the short term potential for a fall in the index. Traders may look to short now, or wait for a move below the 4,450 support. Investors may hold off for the moment, until the market clears this level or a sell off occurs.