Aroon

Advertisement

Introduction

Technical indicators are great tools for traders to fine tune their trading decisions. In order to maximize the benefits of indicators, traders need to know which indicators work best in trending markets and which ones work best in trendless markets. By using the Aroon indicator can help traders determine when a market is up trending, down trending, or is in a trendless market. Once you are able to figure out what the market conditions are, then choosing the right indicator to use becomes much easier.

The Aroon indicator was developed by Tushar Chande in 1995 to determine whether a stock is currently trending or not and if it was trending how strong the trend is. Traders can also use the Aroon to identify the beginning of a new trend, consolidations, spot correction periods and reversals. The indicator is made up of two lines, Aroon-Up and Aroon-Down.

What makes the Aroon Indicator unique among technical indicators is that it analyses the time versus price on a relative basis. The Aroon-Up line is the amount of time between the start of a time period and the point at which the highest price during that period occurred on percentage basis.  Conversely, The Aroon-Down is the amount of time between the start of a time period and the point at which the lowest price during that period occurred on percentage basis.

Calculation

 

If we take a look at these formulas, it is apparent that they are both looking at how recent the latest highs and lows were in a given period on percentage basis. Aroon-Up values will show more recent highs and lows, while Aroon-Down will show less recent highs and lows. The Aroon Indicator fluctuates between 100 and 0. Higher Aroon numbers suggests a stronger trend and a lower numbers indicate no or weakening trend.

Advertisement

Interpretation

To utilize the Aroon indicators traders will monitor three basic levels, which are the centre line of 50, 70-100 and 0-30 areas of the indicator.  As mentioned before the indicator is designed to be bound between 0 and 100. When the Aroon lines move above the centre line 50, it is interpreted that that is an upward bias in the market and bullish traders are in control. When the Aroon lines move below 50, it is interpreted that there is downward bias in the market and the bears are in control. To explain further, when either the Aroon- Up or Aroon-Down lines move to 100, the Aroon indicator is signalling that that a trend may be emerging. This is confirmed with a decline in the other Aroon indicator. When a bullish trend begins, the Aroon- Up will move to 100 and the Aroon-Down will move below 30. When the Aroon lines are reading 100 we know that the price action is consistently making new highs or lows for the specified period. Chande used 25 periods as his default for the Aroon indicator. When Aroon-Up stays above the 70-100 range for an extended period of time prices are consistently making new highs. When the Aroon-Down remains above the 70-100 range for an extended period of time prices are consistently making lower lows. When the market is range bound the Aroon lines with remain remains in the 0-30 range for an extended period.

Aroon Oscillator

Chande build up the Aroon Indicator with the development of the Aroon oscillator. The Aroon oscillator is simply plots the difference between the Aroon-up and the Aroon-down lines. This may be easier for some traders to read then the original Aroon indicator. Unlike the original Aroon, the oscillator is plotted between -100 and 100. The centre line at zero is the major signal line that determines the strength of the trend. The higher the value is above the centre line, the stronger the uptrend.  Conversely, the lower the oscillator line is below from the centre line the stronger downtrend.

Conclusion

The Aroon indicator is a good tool for traders who are primarily interested in determining if market conditions are trending or not trending. By utilizing the Aroon indicator traders can avoid using the wrong technical indicators and choosing the specific indicators for range bound markets and other for trending markets.