Aroon Indicator
The Aroon Indicator is used to identify the existence, changes, and corrective retracements and gauge the strength of an ongoing trend in financial markets.
Definition and components
The Aroon Indicator, developed by Tushar Chande in 1995, helps traders determine whether a market is trending and the strength of that trend. It consists of two lines: Aroon Up and Aroon Down. These lines measure the number of periods since the highest high and the lowest low within a specified time frame, typically 25 days.
Calculation
- Aroon Up: Calculated as:
(๐๐ข๐๐๐๐ ๐๐๐๐๐๐๐๐๐ โ๐๐๐๐๐๐๐ ๐ ๐๐๐๐โ๐๐โ๐๐ ๐กโ๐๐โ)/๐๐ข๐๐๐๐ ๐๐๐๐๐๐๐๐๐ ร100ย
- Aroon Down: Calculated as:
(๐๐ข๐๐๐๐ ๐๐๐๐๐๐๐๐๐ โ๐๐๐๐๐๐๐ ๐ ๐๐๐๐๐๐๐ค๐๐ ๐ก๐๐๐ค)/๐๐ข๐๐๐๐ ๐๐๐๐๐๐๐๐๐ ร100
Both indicators oscillate between 0 and 100. Higher values indicate a stronger trend in that direction.
Interpretation
Identifying Trends: When Aroon Up is above 70 and Aroon Down is below 30, it indicates a strong upward trend. Conversely, if Aroon Down is above 70 and Aroon Up is below 30, it signals a strong downward trend.
Trend Strength: Values near 100 indicate a strong trend, while values near 0 suggest a weak trend or no trend.
Crossovers: When Aroon Up crosses above Aroon Down, it may indicate the start of an upward trend. When Aroon Down crosses above Aroon Up, it suggests the beginning of a downward trend.
Consolidation: When both lines are below 50, it suggests the market is in consolidation and not trending strongly in either direction.
Practical applications
Entry and Exit Points: Traders use the Aroon Indicator to identify optimal entry and exit points. For example, entering a long position when Aroon Up crosses above 70 and exiting when it falls below 50.
Confirming Trends: The indicator confirms trends identified by other tools. For instance, combining Aroon with moving averages or the Relative Strength Index (RSI) provides more robust signals.
Avoiding Whipsaws: By highlighting strong trends, the Aroon Indicator helps traders avoid whipsaws in choppy markets. This can be particularly useful in volatile trading environments.
Limitations
Lagging Indicator: Like many trend-following tools, the Aroon Indicator may lag, providing signals after a trend has already started.
False Signals: In volatile or sideways markets, the indicator can give false signals, leading to potential losses.
Example
Consider a stock with the highest high occurring 5 days ago and the lowest low occurring 15 days ago in a 25-day period:
- Aroon Up: (25โ5) / 25ร100 = 80
- Aroon Down: (25โ15) / 25ร100 = 40
In this scenario, an Aroon Up value of 80 indicates a strong upward trend, while an Aroon Down value of 40 suggests a weaker downward trend.
Final thoughts
The Aroon Indicator is a valuable tool for identifying trends, measuring their strength, and signaling potential changes in direction. While it has limitations, it remains a popular choice among traders for its simplicity and effectiveness in trend analysis. Proper use in conjunction with other indicators can enhance trading strategies and decision-making processes.