The Aroon Indicator Explained

IntermediateOct 19, 2023
The Aroon indicator is a momentum indicator that gives insight into underlying market trends and direction. When used correctly, investors can maximize profits from a trending market and time trade exits.
The Aroon Indicator Explained

The Aroon indicator is a unique tool created in 1995 by a seasoned technical analyst and author named Tushar Chande. Aroon means “dawn’s early light” in Sanskrit (an ancient Indo-European language). Chande gave the indicator its unique name (Aroon) because it could be used to spot new trends early.

While the indicator is imperfect, it has been quite effective. The Aroon indicator can predict a change in market direction. Close to 30 years after its inception, cryptocurrency traders still use the indicator today. The indicator can also be used in the stock and Forex markets. This article sheds more light on the indicator and how it can be used.

Understanding the Aroon Indicator

The Aroon indicator is a technical analysis tool used to assess the strength of a trend and anticipate potential reversals. It also helps traders to predict future price movements, helping them to make quick decisions.

Technical analysis oscillators help traders determine a trend’s direction, momentum, and strength. Charting platforms classify the Aroon indicator as an oscillator because it is a momentum indicator that helps identify trends.

Although the Aroon indicator is less popular than other momentum indicators like the RSI or stochastics oscillator, it helps trending markets and range-bound market conditions.

The Aroon indicator is considered a lagging Indicator because it deals with time relative to price. It measures how much time has passed since the price recorded a new high or low. The fact that the indicator lags makes it valuable because if a market continuously prints news highs or lows within a specified time (set by the trader), it signals a strong market trend.

Understanding the Aroon Components

The Aroon indicator has two components called AroonUp and AroonDown. The default setting for the period set on the indicator is 25, and the results from the indicator’s values are expressed in percentages from 0-100.

The AroonUp measures the strength of an uptrend. It measures how much time has passed since an asset recorded a new high. The AroonDown measures the strength of a downtrend. It measures how much time has passed since an asset recorded a new low. On most trading platforms, the AroonUp is usually represented by an orange or red line, while the AroonDown is represented by a blue line, as indicated below;

Source: Tradingview

The Aroon oscillator’s value is calculated by subtracting the AroonDown from the AroonUp. Mathematically, it is represented like this: AroonUp - AroonDown. The formula for calculating the two components is thus;

AroonUp = {(n _period - periods since highest value within the _n period)/ _n _period} × 100

AroonDown = {(n period - periods since lowest value within the _n _period)/ n period} ×100. Where _n _refers to a specified period chosen by the trader, by default, this _n _period is set to 25.

So a default calculation for the AroonUp would be: {(25 - periods since 25-day high)/ 25} × 100

AroonDown down calculates thus: {(25-periods since 25-day low)/ 25} × 100.

To understand this concept better, suppose that an asset’s price recorded a new high two days ago; the AroonUp indicator’s value would read 92, calculated as {(25-2)/25} × 100. The AroonDown will have similar calculations if the market makes new lows.

These two components work together to offer insights into the strength and direction of a trend. When compared together, an investor can determine when an asset is in a downtrend, an uptrend, or ranging.

Suppose the AroonUp indicator’s value is close to 100 while the AroonDown’s is close to 0. Such a reading could signify a strong uptrend and vice-versa. When traders observe the relationship between these two components, they can better assess and evaluate if an asset is trending strongly in a particular direction, balanced, ranging, or on the verge of a reversal.

Interpreting Aroon Readings

The Aroon values range between 0-100. This range helps investors evaluate trend strength. As explained, the AroonUp value tells the strength of an uptrend, while the AroonDown value helps an investor determine how strong a downtrend is.

The most significant levels of the Aroon indicator scales are 0, 50, and 100 readings. Readings close to 0 and 100 signal a strong trend, while readings around 50 indicate a consolidation.

To get the best of the Aroon indicator, Tushar Chande recommends using the default setting of 25 to get a more accurate reading. Based on the default 25-period setting, the implication is that when the AroonUp indicator reads above 50, the price has recorded new highs over the last 12.5 periods, and vice versa for the AroonDown indicator.

How to Use the Aroon Indicator in Your Trading Strategy

Traders can integrate the Aroon indicator into their trading strategies to analyze an asset’s price action. Some of these strategies are:

Aroon Indicator for Identifying Trends

When either the AroonUp or AroonDown stays above the 70 scale or below the 30 scale, it signals an emerging bullish or bearish trend. In the image below, the default setting for the period on Tradingview is 14 instead of 25. For this illustration, the period is set to the recommended 25-period.

Source: Tradingview

The chart illustrates how the Aroon indicator signals the emergence of a bullish trend. The AroonUp (represented by the orange line) stays above the 70 range for an extended time, while the AroonDown (represented by the blue line) remains below the 30 range. This scenario indicates a strong bullish trend, and traders can look for buying opportunities.

On the other hand, if a trader has been in a short position and sees the indication from the Aroon indicator of an emerging bullish run, the trader can wisely choose to close the open position. The reverse is the case for a bearish trend.

When the AroonUp stays above the 30-70 scale while the AroonDown remains below the 30-0 scale, it signals the emergence of a possible new uptrend. An emerging downtrend may be imminent when the AroonDown stays above the 30-70 scale while the AroonUp stays below the 30-0 scale. When either the AroonUp or AroonDown stays at 100, the market is in a clear downtrend or uptrend.

Aroon Indicator for Timing Entries and Exits

Investors can determine and plan entries and exits as the Aroon components move up and down the range. Since the Aroon indicators signal the strength of bullish or bearish intent, how they interact with each other along the scale can help traders manage their trades.

The Aroon crossovers can help traders spot reversal points. If the AroonUp crosses above the AroonDown line, it signals to an investor to take a long order. If the AroonDown crosses above the AroonUp line, it signals a trader to take a short order. When both lines are flat or parallel without crossing each other, the market is either ranging or consolidating. The scenario for a bearish trend is illustrated in the chart below;

Source: Tradingview

A trader who faces such a scenario could look for selling opportunities because the bearish trend is further confirmed with the Aroon crossovers. At the same time, the AroonDown line continuously stays above the 30-70 scale and the AroonUp line.

Just as the Aroon crossovers can point to entry signals, investors can also use it to time exits by waiting for a crossover in the opposite direction of their trades.

For example, suppose an investor is in a short trade position, and the AroonUp crosses above the AroonDown. In that case, the investor can exit the short trade position because the crossover implies that the market has shifted to a bullish trend and a potential breakout is underway.

Aroon Indicator in Conjunction with Other Tools

The Aroon indicator is lagging because a trend has already been established before the indicator could notify an investor. To avoid or reduce the possibility of false signals, investors can combine the signals from the Aroon indicator with other technical indicators such as the Moving Averages or RSI.

The convergence of multiple indicators can enhance the validity of trade signals and boost a trader’s confidence to take a trade. If two or more technical indicators or strategies point toward the same trade direction, it is better than using only the signal from the Aroon indicator.

How to Use the Aroon Indicator to Identify Emerging Crypto Trends

After an investor selects a cryptocurrency of interest, the Aroon indicator can effectively spot a preferable time to buy the chosen token using the earlier strategies.

To illustrate, assuming an investor is interested in trading MANA/USDT on the spot market. The investor can compare the AroonUp and AroonDown down on multiple timeframes to determine if it is best to buy or sell and when it is the best time to do so.

Source: Tradingview

The chart above depicts a scenario where an investor combines the Aroon indicator with other trading strategies like support and resistance to make trading decisions. MANA/USDT has broken a significant support level on the daily timeframe and has retested it, forming a resistance. The Aroon indicator confirms the bearish trend when the AroonDown line crosses above the AroonUp line and stays above the 70 scale. An investor may then take a short entry while keeping an eye on the Aroon indicator for potential reversals to exit the short position.

Tips to Effectively Use the Aroon Indicator

Traders can maximize the benefits of using the Aroon indicator by;

Adapting to Different Timeframes

Select appropriate timeframes based on your trading goals. If you intend to swing a trade position, using the Aroon indicator on a higher timeframe than a smaller one is best.

The Aroon indicator identifies a trend based on the timeframe it is used. An asset in a strong bullish trend on a 15-minute chart might be a retracement on a daily timeframe.

Regularly Monitor and Adjust

Regularly assess the chosen settings for the Aroon indicator to ensure its relevance to the timeframe you are using and evaluation of the trend.

Combine with Risk Management

Always incorporate good risk management practices alongside Aroon-based strategies. Use appropriate position sizing and avoid over-leveraging.

Pros of Using the Aroon Indicator

  • It is useful in both trending and consolidating phases of the market.
  • Traders can maximize profits by holding trades because the indicator highlights when a long trend develops.
  • It is simple to interpret and read and easily customizable to a trader’s preference.

Cons of Using the Aroon Indicator

  • Because the indicator is lagging, traders can miss out on trade opportunities at the immediate start of the trend.
  • In choppy and ranging markets, the indicator can generate false signals due to the rapid change in price movements.
  • The indicator measures the time that has passed when an asset made a new high or low. Price may have changed within this timeframe, and the indicator would still need to reflect it, leading to mistakes in trading decisions.

Conclusion

The Aroon Indicator is a helpful tool for traders. It gives information about market trends when they are strong or might change. It is important to remember that the indicator acts as a guide and not an infallible signal pointer.

Whether as new or experienced traders, the Aroon Indicator can be handy. You can use the indicator with different timeframes and always manage risks. Combine the signals with other technical indicators and tools for better results.

Author: Bravo
Translator: Sonia
Reviewer(s): Matheus、Edward、Ashley He
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