In this blog, we will understand the Aroon Indicator, also known as Aroon Oscillator.
What is Aroon Indicator?
In 1995 Tushar Chande, a principal of Tuscarora Capital Management and author of "The New Technical Trader" (1994) and "Beyond Technical Analysis" (2001), developed the Aroon indicator. It is extremely useful in capturing the trend and identifying range-bound markets.
How to calculate Aroon Indicator?
First, let us understand how Aroon is calculated. Aroon Indicator has two parts to it.
AroonUp is used to measure the upside trend and AroonDown is used to measure the downside trend. Usually, AroonUp is calculated using the Highs and AroonDown is calculated using the Lows, but you can also only use the close prices to calculate them.
To calculate the AroonUp value you need to know 2 things:
- The lookback period
- The period since the highest high was made
Let us say that you have chosen a 14-period lookback, then we need to check for the highest high/close in the last 14 periods.
Let us say that the highest high occurred at the 4th latest candle. Then AroonUp is calculated as below:
AroonUp = (Lookback - (Periods Since Highest High))/(Lookback)
Therefore, AroonUp = (14- 4)/14
ie. AroonUp = 0.7142
As you must have noticed, the Aroon Indicator is a percentage value. It simply represents how recent are the highest high/ lowest low in the past ‘X’ Periods. The AroonUp value calculated above is multiplied 100 to represent it in a percentage format.
AroonUp = 0.7142*100
ie. AroonUp = 71.42
Similarly, the AroonDown is calculated using the lowest low in the past X periods.
AroonUp = (Lookback - (Periods Since Lowest Low)) / (Lookback)
The two Aroon indicators are subtracted to calculate the Aroon oscillator.
AroonOscillator = AroonUp - AroonDown
Although the Aroon oscillator is a simple way of representing both the indicators. Let us understand how to interpret these indicators in detail.
Interpretation of Aroon Indicator
Markets are said to be trending up when the AroonUp value is more than the AroonDown value.
But this crossover of Aroon indicators is not considered a strong signal, instead, it is seen as the beginning of the trend. The confirmation of up trend happens only when the AroonUp value goes above 50.
In the above figure, the green Aroon line represents the AroonUp value which is above the red line or AroonDown line, whenever the market was trending up.
You can also interpret this using an Aroon oscillator, if the Aroon oscillator is above zero it signals an Uptrend and if it is above 100 you consider it as a confirmation of Uptrend and if it is below -100 then we can confirm it as a downtrend.
Aroon indicators can also be used to identify the range bound market. Whenever the AroonUp and AroonDown indicators are parallel or when the Aroon oscillator is flat, it indicates a range bound market. If you are an intraday scalper then this flat range is ideal for your trading.
Like all technical indicators, Aroon is also a lagging indicator. So, it is susceptible to sudden spikes. To protect against such volatility, the traders should have efficient exit criterion in place.
We have successfully applied the Aroon indicator combined with RSI to generate trading signals in our course on Cryptocurrency trading.
Disclaimer: All investments and trading in the stock market involve risk. Any decisions to place trades in the financial markets, including trading in stock or options or other financial instruments is a personal decision that should only be made after thorough research, including a personal risk and financial assessment and the engagement of professional assistance to the extent you believe necessary. The trading strategies or related information mentioned in this article is for informational purposes only.