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Why Trade Indices CFDs
- What is Aroon Indicator
- Calculating the Aroon Indicators
- What the Aroon Oscillator Teaches Us
- Interpreting the Aroon Indicators
- Final words
The Aroon indicators are a type of momentum oscillator that was developed in 1995 by Tushar Chande. It tells whether an asset is trending and how strong that trend is.
He called his new oscillator “Aroon” because it means “Dawn’s Early Light” in the Sanskrit language. He felt that was a good description of the oscillator, which focuses on time relative to price, and is often used to spot emerging trends and to anticipate reversals, making it an early warning system for price action. It can also be used to locate correction periods and to identify when the market is consolidating.
While the Aroon indicators are used to measure how long it’s been since price posted a new high or low, and can be used with any time frame; it is most commonly calculated using 25-periods.
The Aroon oscillator consists of two different indicators:
- An Aroon-Up indicator that measures how many days it’s been since a 25-day high was recorded;
- An Aroon-Down indicator that measures how many days it’s been since a 25-day low was recorded.
Both Aroon indicators are expressed in percentage terms, with reading ranging from 0 to 100. The Aroon up line and the Aroon down line are plotted side-by-side to make interpretation easier.
Calculating the Aroon Indicators
Calculating the Aroon indicators is not as complicated as you may think. It merely requires the high and low prices of an asset be tracked for the number of periods being used for the formula. As mentioned earlier, nearly all use 25 periods as recommended by Tushar Chande.
- Track the price highs and lows of the asset for the last 25 periods.
- Make note of how long it’s been since the last high and low.
- Use these numbers in the Aroon-Up and Aroon-Down formulas which follow.
Aroon-Up = ((25 – Days Since 25-day High)/25) x 100
Aroon-Down = ((25 – Days Since 25-day Low)/25) x 100
What the Aroon Oscillator Teaches Us
As mentioned above, both the Aroon-Up and the Aroon-Down are expressed in percentage terms and move between 0 and 100.
When looking at the scale, the higher the indicator’s value, the stronger the underlying trend. As an example, if the price of an asset reached a new high just one day ago the Aroon-Up indicator would have a value of 96 ((25 – 1) / 25) x 100) = 96. The same would be true for the Aroon-Down indicator when price reaches a new low one day before.
This indicator presumes that during any uptrend, the price will continue to make new highs on a regular basis, and during a downtrend, price will consistently make new lows.
Even though the indicator is typically based on 25 periods, it is expressed in terms of 0 to 100. This means whenever the Aroon-Up indicator is above 50 prices has made a new high within the past 12.5 periods.
The same applies to the Aroon-Down indicator. When it is above 50 it means a new low was posted within the last 12.5 periods. In either case a reading near 100 indicates a very strong trend.
Traders can also watch for Aroon chart crossovers of the up line and down line as these can signal entry or exits. Watch for the Aroon-Up to cross above the Aroon-Down for a buy signal, or for the Aroon-Down to cross above the Aroon-Up as a sell signal.
In some cases, you may find that both indicators are below 50, and this indicates price is in a consolidation phase. This occurs when there are no new highs or lows recently.
When prices are consolidating like this a trader can put the asset on their watch list and wait for a breakout or for the next Aroon crossover to get an indication of where price is headed next.
Interpreting the Aroon Indicators
Interpreting the oscillator is important for developing Aroon indicator strategies. There are three levels in the scale that are most important in interpreting the Aroon indicators. These are the 0, 50, and 100 readings.
In the most basic interpretation we say that the market is bullish when Aroon-Up is above 50 and Aroon-Down is below 50. This set-up indicates new daily highs are more likely than new daily lows. And the opposite is true for a downtrend. In that case, the Aroon-Down is above 50, while the Aroon-Up is below 50.
New Trend Indicated
An emerging trend occurs in three phases. If we’re looking at a new uptrend emerging the first sign is when the Aroon-Up crosses above the Aroon-Down. This signals new highs are becoming more frequent recently than new lows.
The next sign is when the Aroon-Up moves above 50 and the Aroon-Down moves below 50.
The third and final sign is when the Aroon-Up reaches 100, while the Aroon-Down remains at extremely low levels, usually below 30.
Note that the first two signs can occur in any order. In some cases, Aroon-Up will cross above 50 first, and will then cross above the Aroon-Down indicator.
In the case of a downtrend simply reverse the indicators and look for Aroon-Down to break above 50, cross above Aroon-Up, and reach 100.
There are two signs a consolidation period is emerging. One is if both the Aroon-Up and the Aroon-Down are below 50. The other is if both Aroon-Up and Aroon-Down are moving lower in parallel.
It makes sense that if both readings are below 50 it indicates consolidation. A reading below 50 for both indicators means there have been no new highs or lows recorded in over 13 days. It’s evident that prices are flat and consolidating when no new highs or lows are being recorded.
When both indicator lines move lower in parallel, it indicates a trading range has formed, with no new highs or lows being posted.
Limitations of the Aroon Indicator
There are some downsides to using the Aroon indicator. One is that during choppy market action the indicator will give poor trading signals as the rapid changes in price cause the oscillator to whipsaw back and forth.
There are also times when the indicator provides a valid trade signal, but it is too late to be useful. Price may have already made a significant move up or down and be ready to retrace when the trade signal first appears.
The Aroon indicator is most accurate and useful when combined with analysis of price action and other technical indicators, as well as with fundamental analysis if long term trades are being placed.
The Aroon indicator is rather intuitive and easy to learn, even for those who have only recently started to trade. However, in order to be able to interpret data more reliably and accurately, we highly recommend testing your strategies using this indicator with a risk-free demo account.
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