What is Aroon Indicator?

The Aroon indicator in the trading spectrum is a lesser-known yet powerful technical analysis tool for traders. Back in 1995, Tushar Chande developed it, and in Sanskrit it means ‘early light of the dawn’.

As the name implies, this indicator, using a time-based analysis, helps identify the start of a new price trend of an asset and also gauges its strength.

Traders and investors are increasing in India, with 9.5 crore people already investing in stocks directly. As a trader, you must also learn this indicator to make informed decisions for trades.

Meaning of the Aroon Indicator on Trading Charts

As a trader, while trading with a technical analysis chart, such as bar or candlestick charts, you can locate an Aroon indicator beneath them. Under these charts, the indicator is placed, and they range between 0 and 100 in values. This indicator is typically made up of two different indicators, such as:

1. Aroon Up

   On a trading chart, it calculates the time for which prices of an asset went up and recorded new highs for a specific period. You can locate it as a line on a chart as a green line, and traders consider it a Bullish Aroon. Being bullish, it indicates a potential uptrend in asset prices that you are tracking.

2. Aroon Down

   Another associated indicator here is the Aroon Down, which, as a trader, you might refer to as a bearish Aroon. Opposite to an Aroon up, it measures the time frame for which asset prices recorded new lows within a specified time. Being a bearish signal or indicator, it indicates a possible downtrend in your favoured asset prices.

Understanding the Working Mechanism of an Aroon Indicator

You already know that you can locate this indicator underneath a bar, candlestick or other sorts of charts. However, to work, both indicators (Arron up and down) appear as one below the other. Here is a detailed view of how differently they appear and work as an indicator:

1. Decoding the Indicator Position

   On a trading chart, if the first line or a green line appears above the second or red line. It indicates a possible uptrend. On the other hand, if the red line appears first and crosses beyond the green line, it indicates that a potential price downtrend might be near.

2. Understanding the Values of Aroon Up

   Apart from the stock price changes, you must consider its own values to confirm trends. On an Aroon indicator, if the green line or Aroon up touches 100, it indicates that an uptrend has started. If it consistently stays between 70 and 100 with its down indicator remaining between 0 and 30, it shows that a potential uptrend is nearby.

3. Values of Aroon Down

   While looking into a trading chart, if you see the red line or an Aroon down inside an Aroon indicator having a value of 100, it indicates that the price downtrend is already here. Furthermore, if its value hovers between 70 and 100 persistently while the upward line remains between 0 and 30, it shows that a possible price downtrend might be close.

4. Phase of Consolidation

   If you are curious about how to locate consolidation, you need to look at the position of both Aroon up and down. Here, both lines might move parallel, almost at the same level, and indicate a consolidation.

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Applicable Formula of an Aroon Indicator

Upon having an idea of what is aroon indicator, you must also have a look at the Aroon indicator formula:

1. The formula applicable for Aroon Up

   With information such as the number of periods for stock trend analysis, the number of periods since a stock reached its highest, etc., you can decide on ‘Aroon up’ with the following formula:

   Aroon Up= [(Number of periods– Number of periods since a highest high)/Number of periods)] *100.

   By placing the information accordingly, you can confirm whether the stock has recently made a new high and how strong the uptrend is.

2. Formula to Use for an Aroon Low

   To calculate a bullish Aroon or a downward trend line on an Aroon indicator, you must employ the following formula:

   Aroon Down = [(Number of periods– Number of periods since a lowest low)/Number of periods)] *100.

   An Aroon indicator typically considers 25 as its ‘number of periods’ for analysing the price trend and its strength. However, its value still ranges between 0 and 100.

How to Calculate the Aroon Indicator?

Now that you know the applicable formulas for highs and lows in an Aroon indicator, you must have a look at an explanation of how this formula decides on price ranges.

In case an Aroon up value is more than 50, it indicates a new high was recorded during the first half of the said period, i.e. within 12.5 days:

1. Explanation of Aroon Up Calculation

   If we resort to an example and suppose that a stock price has reached its highest high in the last 5 days, here is how you calculate the Aroon up:

   Aroon Up = [(25-5)/25]*100 = 80. As this value is beyond 50, it indicates that the stock price indeed reached its highest high in the last 12.5 days.

   A value of its high below 50 also provides a different insight. Suppose the last highest high a stock reached was 15 days ago. You calculate it as

   Aroon Up = [(25-15)/25]*100 = 40. Being the value below 50, it indicates that apart from its high 15 days ago, the stock again has not reached a highest high at least in the last 12.5 days.

2. Explanation of Calculating Aroon Down

   Similar to the calculation of an Aroon up, you calculate an Aroon down depending on the value of 50.

   For example, suppose a stock you have been tracking reached its lowest low in the last 7 days:

   Here, Aroon Down = [(25-7)/25]*100 = 72. As this value is greater than 50, it confirms that this stock indeed reached its lowest low in the last 12.5 days.

   To confirm that a stock has not reached its lowest low in the last 12.5 days, you must employ the same formula accordingly. Suppose the last recorded lowest low was 20 days ago:

   Aroon Down = [(25-20)/25]*100 = 20. Being the value lower than 50, it shows that this stock has not recorded a new low in the last 12.5 days.

   Thus, these calculations clearly indicate whether a stock has made a fresh high or a low within the recent 12.5-day window. By knowing this, as a trader, you can decide more accurately whether to stay with the trend, enter, or exit a trade based on the real momentum of a new trend rather than guesswork.

A Guide to the Aroon Indicator Strategy in Trading

Especially if you are a swing or a trend trader or simply curious about this indicator, you must learn how to strategise for a bullish and bearish market:

1. Trade Setup During a Bullish Market

   Here is a 5-step guide that you can follow to use insights from an Aroon indicator during trading:

   Step 1: You must first locate a strong bullish signal from the insights of this indicator. For example, a strong upward trend might be near, if Aroon up is above 70, Aroon down is below 30. Here, both lines stay in this zone for a range of candles.

   Step 2: Here, you must look out for a price breakout either at a resistance level or a zone of price consolidation. You might also use additional confirmation from RSI and MACD.

   Step 3: Enter the market by opening a long position when your chosen asset’s price breaks beyond the resistance. Also, you can enter a long position when there is a minor pullback.

   Step 4: Place a stop-loss below the asset’s key support or beneath the recent swing low. You might also choose a fixed percentage, such as between 1.5% and 2% depending on volatility.

   Step 5: Define your exit strategy by targeting recent swing highs. You might also go for a fixed risk-to-reward ratio, such as 2:1. Exit the market if Aroon Up goes below 50 and Aroon Down rises. These indicate that a bullish momentum is now weakening.

2. Trade Setup During a Bearish Market

   For setting trades during a bearish market, you must follow the above 5 steps, but make some minor tweaks accordingly. During a bearish momentum, look for ‘Aroon down’ beyond 70 and ‘Aroon up’ to be below 30. For breakouts, locate it below its support level and confirm momentum. Follow the entry and exit logic as detailed, but in reverse.

Advantages of the Aroon Indicator

Aside from the Aroon indicator strategy, its calculation, etc, you must also learn its advantages specifically:

1. Early Trend Identification

   Aroon indicators have the potential to indicate emerging price trends earlier. It often indicates price trends even before a price breaks out beyond resistance or below the support level. This makes it effective for swing traders, trend traders, etc.

2. Clear Zones for Trend Signal

   With the 70-30 levels for both Aroon up and down, you can easily understand or identify a strong bullish or bearish momentum. It lets you make trade decisions efficiently.

Disadvantages of the Aroon Indicator

Aside from noting its advantages, you must also stay informed about its limitations to steer clear of making wrong trade decisions:

1. Might Lag in Volatile Market

   Although it has a potential for early trend projection, during a volatile market, its indications might lag. When prices rapidly go up and down during high volatility, there is a chance of it generating delayed and even false signals.

2. Less Effective in Ranges

   Aside from volatility, if the market goes sideways, as a trader, you might find the Aroon indicator less effective. As in a sideways market, highs and lows reset frequently, which might indicate entry points that might be premature and lead to losses.

Conclusion

An Aroon indicator is a technical analysis tool which uses specific formulas to detect the beginning of a new trend. You can locate it beneath a candle, bar or any other sort of chart, and it consists of a high and low line.

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FAQ’s on Aroon Indicator

1. How accurate is the Aroon indicator?

This indicator might be effective in detecting trends for swing or trend-traders. Hoover, there are chances that it might lag in a sideways market or in a highly volatile one.

2. What is the difference between MACD and Aroon?

An MACD uses a moving average to measure price momentum, whereas an Aroon indicator measures this movement using highs and lows of assets.

3. Can the Aroon Indicator be used to identify potential trend changes in the market?

Yes, using formulas such as Aroon up and Aroon down, this indicator locates a trend change or the beginning of a new trend.

4. What is an example of the Aroon Indicator used in Trading?

While looking at an Aroon indicator, if the corresponding line for Aroon up crosses above the Aroon down, it indicates a possible uptrend. It shows a downtrend if the Aroon down crosses the Aroon up.