Technical analysis is one of the most recognizable types of trading practices, especially in finance. Analysts use it to evaluate investments and identify trading opportunities by dissecting statistical trends from trading activity like price movement and volume. One of the key tools for this analysis is the indicators.
When it comes to finance, technical indicators are mathematical calculations. They draw data from historic price, volume, or – in the case of futures contracts – open interest information. It is a popular technique that aims to predict financial market direction. Technical indicators play an essential role in technical analysis, tying into the analysis’s main goal of identifying trends. More often than not, they are plotted as a chart pattern to try to forecast the market trend.
There are a variety of indicators, but the one we will be focusing on today is the ‘Aroon indicator’.
In regards to day trading, strategies that derive from the Aroon indicator are the best of the best. They are the ideal methods for you to apply in order to make quick and easy profits in the markets. Aroon is one of several technical indicators that are capable of helping you achieve continuous success with trend trading. Not only that but also trading within a range.
What is it?
The Aroon indicator is a technical indicator whose purpose is to identify trend changes in an asset’s price. In addition, it helps detect the overall strength of that particular trend. Essentially, the indicator measures the time between highs and the time between lows over a specific time period. The person responsible for creating the Aroon indicator was Tushar Chande back in 1995. Chaise chose the name “Aroon” because it derives from the Sanskrit language, roughly translating to “dawn’s early light.”
The core idea of the indicator is that strong uptrends will see new highs on a regular basis. In a similar vein, strong downtrends will repeatedly see new lows. The indicator will signal whenever this is happening, as well as when it isn’t.
If you have been partaking in day trading for some time, you will have likely noticed something interesting about a stock’s price or security. Oftentimes, they will remain within a certain range, where the price will move in an impulsive manner. During trading hours, the price typically trends up or down only a small percentage of the time.
Like other indicators, the Aroon indicator has its own formula. Its development was done in a way that allows it to anticipate a change in the price action of a security. Specifically, when it transitions from a range-bound state to a trending state. This way, you are able to establish either a long position or a short position. Moreover, it can pinpoint when the price action of a security will presumably stop trending and instead start consolidating.
What it tells you
‘Aroon Down’ and ‘Aroon Up’ are two lines that, when put together, create the Aroon indicator we know and love. If you want to use this indicator, it is imperative that you understand the importance of these components.
Aroon Up measures the length of time since prices were recording a new high within a specific period. If the high of the current bar is the highest within the user-defined number of periods beforehand, that means the Aroon Up value is 100. Put simply, it indicates a new high for that particular period. In different circumstances, it returns a percent value suggesting the time since the occurrence of a new high for the period.
Aroon Down is similar to Aroon Up, but its calculation is on the opposite end of the spectrum. This line measures the length of time since prices were recording a new low within a specific period. Suppose that the current bar’s low is the lowest within the user-defined number of periods prior to it. In this case, the Aroon Down value is 100. It is, in other words, a new low for that period. Otherwise, it will return a percent value that’s indicative of the time since the new low’s occurrences for that period.
What about the Oscillator?
Before we move forward, we should first take a look at the ‘Aroon Oscillator’. It’s a trend-following indicator that utilizes aspects of the Aroon Indicator (i.e. the Aroon Up and Aroon Down) in its operation. The oscillator uses the indicator to evaluate the overall strength of a current trend and the likelihood of it continuing.
Readings that fall above zero imply that an uptrend is present. Readings falling below zero, however, indicate that a downtrend is present. Traders watch closely for zero line crossovers, which typically signal any potential changes in trends. Additionally, they keep an eye out for noticeably big moves, above 50 or below -50 that indicate strong price moves.
The Aroon Oscillator is capable of plenty of two important things. One is it is able to generate an array of trade signals. Another is it can provide substantial insight into an asset’s current trend direction.
Whenever the oscillator moves above the zero line, this means that the Aroon Up is crossing above the Aroon Down. This is indicative of the price effectively producing a high more recently than a low. This is likely to be a sign that an uptrend is commencing. In a situation where the oscillator moves below zero, it signals the Aroon Down crossing below the Aroon Up. The occurrence of a low is more recent than a high, which probably signals the start of a downtrend.
Crossovers
Analyzing the relationship between Aroon Up and Aroon Down lines can help interpret the price action of a stock. It can do so in three different ways:
- Suppose the momentum in the market transitions from a bullish one to a bearish one, and vice-versa. If this occurs, the Aroon Up or Down will end up crossing over each other and will lead to the sides changing.
- The market trending with strong momentum means that the Aroon indicator will display extreme readings.
- In cases of the market consolidating, the Aroon Up and Aroon Down lines will remain parallel to each other.
You can easily use the Aroon Up and Aroon Down line crossover to help determine the price’s directional movement. In the event of the Aroon Up crossing above the Aroon Down, it will generate a signal. This signal indicates that the price is on the cusp of starting a potential bullish move. Contrarily, when the Aroon Down crosses below the Aroon Up line, it is indicative of a potential bearish move.
With that in mind, it would be wise not to place a buy or sell order whenever there is a new crossover. This is due to there being an indication that the existing trend is undergoing a change. In lieu of this, you should bide your time; wait for the price of the security to break from a range or trend line. Only then can you open a new position in the Aroon’s suggested direction.
How to calculate it
Below are two formulas for the Aroon indicator, with one focusing on the high and the other on the low:
Aroon Up = 25 – Periods since 25 period High / 25 x 100
Aroon Down = 25 – Periods since 25 period Low / 25 x 100
The Aroon calculation requires the tracking of the high and low prices. Moreover, these prices should typically stem from over 25 periods.
- Track an asset’s highs and lows for the previous 25 periods.
- Take note of the number of periods to happen since the last high and low.
- Insert those numbers into the Aroon Up and Down formulas.
It is possible for you to be able to set the Aroon indicator to calculate any number of periods. However, to reiterate, 25 periods is the standard amount that most day traders use the Aroon indicator for. A common recommendation would be that you apply the Aroon indicator strategy to the standard 25 periods, too. This is mostly because it will help you stay more or less “in sync” with other traders in the market.
Periods & Readings
As you can clearly see, the Aroon indicator largely focuses on the previous 25 periods. However, its scale is relegated to zero and 100. Because of this, an Aroon Up reading that surpasses 50 means that the price was successful in making a new high. Moreover, it did so within the last 12.5 periods. A reading that inches close to 100 indicate that there was a very recent high. The exact same concepts apply to the Down Aroon measurement. When the reading is above 50, this indicates the occurrence of a low within the 12.5 periods. A Down reading that is close to 100 means that there was a recent low sighting.
Crossovers are often what signals the entry or exit points. When Up crosses above Down, it usually acts as a signal to buy. Down crossing below Up, on the other hand, may function as a signal to sell.
Let’s imagine a scenario where both indicators wind up falling below 50. In this particular case, it can typically mean that the price is consolidating. Furthermore, there aren’t any new creations of highs or lows. Traders are able to keep an eye out for breakouts, as well as the next Aroon crossover to signal the price direction.
Interpreting extreme readings
Similar to a lot of other oscillators, you can interpret the Aroon indicator readings quite easily. The main method is to base your assumptions on where exactly the Aroon lines reside on the chart. Specifically, in comparison to the value of the corresponding levels it represents.
There are two key levels that you need to watch closely on the Aroon indicator: 80 and 20. You may be wondering how to determine if the price is trending upward. The answer is simple, albeit aggravating if you were hoping to promptly accomplish it. Put simply, you need to wait for when the Aroon Up line surpasses the level 80. If you notice the Aroon Down line staying below Level 20 simultaneously, it effectively confirms the bullish trend in the market. What about if you find the Aroon indicator in this situation? Well, then you should be looking to place a buy order by drawing from your trading system rules.
Contrarily, suppose you are going to place a short order with the stock. Furthermore, you are doing so because you are of the belief that the price broke an important support level. In this case, you can use the Aroon indicator to verify the bearish momentum in the market, too. As one might expect at this point, to confirm a bearish trend, the Aroon Down line has to go below the level 20. Moreover, the Aroon Up line should go in the opposite way; specifically, above the level 80.
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