Easy Guide to the Aroon Indicator for Technical Analysis

The Aroon Indicator is a momentum oscillator developed in 1995 by Tushar Chande. Named after “Dawn’s Early Light” in the Sanskrit language, this indicator is commonly used to identify emerging trends and predict reversals, which makes it an effective way to spot warning signs of price action. It can also be used to discover periods of correction and when the market is consolidating.

Simply put, the Aroon indicators measure the time interval since the last price high or low. Although they can be used for any timeframe, the most popularly used is the 25-period or 25-day timeframe. The results are expressed in percentages, with the reading ranging from 0 to 100. With this, traders attempt to identify:

• Beginning of a trend or trend changes.
• Trending or ranging markets.
• Consolidation periods or corrective retracements.
• Trend strength.

Types of Aroon Indicators

The momentum oscillator consists of 2 indicators:

1. Aroon-Up indicator: This measures the number of days that have passed since the last 25-period high was recorded. A reading of above 50 is considered a signal of a strong uptrend.
2. Aroon-Down indicator: This measures the number of days that have passed since the last 25-period low was recorded. A reading of below 50 is taken as a signal of a downtrend.

When the reading is near 0, it is considered an indication of a ranging market or a market in transition. Unlike other momentum oscillators, the Aroon indicators focus on time relative to asset price rather than asset price relative to time.

How to Calculate the Aroon Indicators

Calculating these indicators isn’t very complicated. All you need is the high and low prices of your chosen asset, tracked for the timeframe you will use for the formula. The Aroon indicators are usually plotted in a separate window from your main price action chart window in percentages, ranging from 0 to 100.

The formulae for the two indicators are:

Aroon-Up: ((25 – Number of days since the last 25-day high)/25) x 100

Aroon-Down: ((25 – Number of days since the last 25-day low)/25) x 100

Higher values reflect a more recent occurrence of a high or low, while lower values show a longer timeframe since the last high or low. Also, higher values indicate stronger trends while lower values signal weaker or absent trends.

You can also use the tools on your trading platform to plot the Aroon indicators, eliminating the hassle of manual calculations. However, practice reading the plotted lines on a demo account before applying the indicators to the live markets.

Interpreting Signals from the Aroon Indicators

Mastering the interpretation of this momentum oscillator is important before including it in your trading strategy. An Aroon-Up indicator above 50 signals a bullish market, indicating that new highs are more likely than fresh lows. On the other hand, when the Aroon-Down indicator is below 50, it signals a higher potential of new lows, indicating a downtrend.

Identifying a New Trend

The crossover of the Aroon-Up and Aroon-Down indicators is used to identify emerging trends. When the Aroon-Up indicator makes a bullish crossover, moving above the Aroon-Down indicator, or the Aroon-Down makes a bearish crossover below the Aroon-Up indicator, it is taken as a signal of a market reversal or trend change. Depending on the crossover, traders interpret the signal as that of an uptrend or downtrend.

There are usually 3 phases of an emerging trend. Let’s use an example of an emerging uptrend to understand this:

1. The Aroon-Up crosses above the Aroon-Down, signalling that new highs are more likely than new lows.
2. The Aroon-Up moves above 50 while the Aroon-Down moves below 50.
3. The Aroon-Up continues to rise towards 100 while the Aroon-Down remains at low levels, typically below 30.

For an emerging downtrend, the Aroon-Down crosses over the Aroon-Up and rises towards 100. It is important to note here that the first two phases of an emerging trend can occur in any order.

Identifying Market Consolidation

There are two signals that the market is entering into a consolidation phase. First, when both the Aroon-Up and Aroon-Down values remain below 50. This means that no new highs or lows were recorded over the past 13 periods, which reflects flat prices. The second signal is when both Aroon indicators move lower in parallel. This indicates the emergence of ranging prices, with no new highs or lows being recorded.

However, like other momentum oscillators, Aroon indicators might also give false signals at times. This is especially true during periods of high volatility or choppy markets. At such times, experienced traders prefer to confirm signals using other indicators. Another limitation of the Aroon indicator is that there are times when it provides signals too late for traders to take advantage of price moves. The asset price might have already moved significantly up or down and be ready to make a retracement by the time the signal appears.

Having said that, the Aroon indicator is an accurate and useful tool for technical analysis, especially when combined with other indicators and fundamental analysis. 

To Sum Up

• The Aroon indicator is a momentum oscillator.
• It is used to identify emerging trends, periods of market consolidation, range-bound markets and trend strength.
• The Aroon momentum oscillator consists of two indicators – the Aroon-Up and Aroon-Down indicators.
• Readings on the Aroon indicators are expressed in percentages and can range from 0 to 100.
• Although these indicators can be used for any timeframe, the most popularly used is the 25-period or 25-day timeframe.
• An emerging trend is identified when one Aroon indicator crosses over the other.
• If both indicators are below 50 or are moving lower parallelly, they signal a ranging market.
• Experienced traders confirm signals from the Aroon indicators with other technical analysis tools.

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