Aroon indicator was developed in 1995 by economist, technical analyst and author of books Tushar Chand, who also created the Chande Momentum and Qstick oscillators. In Sanskrit, "arun" is translated as "dawn", which testifies to his faith in the ability of this tool to predict the direction of trend movement.
In day trading, strategies based on the use of this indicator are among the best. They allow you to make a profit as quickly as possible. This is one of the few technical analysis tools that can help achieve continued success both in trend trading and within resistance and support lines.
The principle of operation of the Aroon indicator
Experienced traders are familiar with a situation where the price of an asset moves impulsively, staying within a clearly defined range. It rises or falls only for a short period during the entire trading session.
The formula for calculating this instrument is selected in such a way as to predict the moment when the value of the asset leaves the state of fluctuation within a limited range, allowing players to open a long or short position. It is also able to indicate when the price will stop moving and begin to consolidate.
Traders who prefer to trade in a trend can use Arun to start trading early and exit early when the trend is about to run out. It is interesting to note that the strategies of this technical analysis tool can also be applied when trading within the levels of support and resistance, since they allow you to generate signals about their breakthrough.
Description
The Aroon indicator is based on two charts, which are usually located at the top and bottom of the price chart.
The formula for calculating the top line of Aroon Up is as follows: [(number of periods) - (number of periods after the price peak)] / (number of periods)] x 100.
The Aroon Down indicator is calculated in the same way: [(number of periods) - (number of periods after the minimum price)] / (number of periods)] x 100.
Although a trader can choose any period of time to calculate this indicator, most players use the number 25 as a standard. Experts recommend that this strategy be used, as this will allow “synchronization” with other market participants.
Interpretation
As you can see, the indicator oscillates between the maximum value of 100% and the minimum value of 0%. In principle, we can analyze the relationship between the Aruna lines and interpret the price movement as follows:
- when market trends change from bull to bear, and vice versa, Aroon Up and Down intersect and change places;
- if the trend is changing rapidly, the indicator shows extreme levels;
- when the market consolidates, the Aruna lines are parallel to each other.
Trend direction definitions
The relative position of the indicator lines makes it easy to determine the direction of price movement. If Aroon Up crosses Aroon Down from the bottom up, a signal is generated that the market is about to begin a bullish reversal. Conversely, if Aroon Down crosses Aroon Up from top to bottom, we can confidently talk about potential bearish movement.
However, you should not place a purchase or sale order at each new intersection, because this indicates a change in the existing trend. Instead, before opening a new position in the direction suggested by Aroon, you must wait until the price breaks a range or trend lines.
Extreme Interpretation
Like most oscillators, the readings of the Aroon indicator can be interpreted based on where its lines are located on the chart compared to the value of the corresponding levels that it represents.
The key chart values to keep track of are 80 and 20 percent. If you need to find out if the price is going up, just wait until the Aroon Up line moves above the 80% level. And if Aroon Down drops below 20, then this will confirm a bullish trend. In such a situation, you should place a purchase order based on the rules of the trading system.
In contrast, if you need to open a short position when the price overcomes the support level, the Arun indicator can be used to confirm the bearish momentum. To do this, the Aroon Down chart should be below 20%, and Aroon Up - on the contrary, above 80%.
However, if one of the charts reaches 100%, you should always monitor the market and try to protect your profit by moving the stop order closer to the price. This is due to the fact that the chart at 100% indicates that the trend has been developing for too long and may be overbought or oversold, and a reversal will occur very soon. This strategy allows you to use the Aroon indicator for binary options.
With strong movement, you should not leave the market as a whole, because any small price correction will actually offer another opportunity to increase the position.
For example, if the Aroon Up line touches the level of 100%, and then drops to 90%, but is still located above the Aroon Down, this indicates a rollback, and you can increase your long position rather than close it. Similarly, during a recession, you should do the opposite and try to build up your short position.
Interpretation of parallel lines
An interesting aspect of the use of the Aroon indicator in day trading is the possibility of its use in markets with limited price dispersion. When an asset's value is consolidated within narrow limits, the Aroon Up and Aroon Down charts are parallel to each other. Periods of consolidation occur at levels below 50%, when neither the bearish nor the bullish trend have sufficient strength. This is especially true when both lines of the indicator in unison move down.
Traders who trade within the resistance and support lines, who like to enter a short position at the peak of the range and open a long one on the support line, the Arun indicator can help identify price consolidation zones and take advantage of such a trading strategy.
If the Aroon Up and Down charts are parallel, then this indicates that a breakthrough will occur soon.
Thus, you should always pay special attention to the price movement in the upper and lower parts of the range when Aroon charts are parallel, as it can break through the resistance line and rush in any direction. Therefore, you should be very careful.
Aroon Oscillator
In addition to the Arun indicator, many technical analysis packages also offer an additional tool of the same name - the oscillator. Its value is calculated by subtracting the value of Aroon Down from Aroon Up. For example, if Aroon Up at a certain time is 100%, and Aroon Down = 25%, then the Aroon Oscillator indicator will be 100% - 25% = 75%. If Aroon Up is 25%, and Aroon Down = 100%, then the oscillator mark will be at the level of -75%.
Often the oscillator is located under the main chart of “Aruna” in the form of a separate histogram so that you can see the strength of the current trend.
If the oscillator value is positive, then the price forms new highs more often than new lows. Conversely, a negative level indicates the prevalence of negative trends. Since the oscillator most of the time is either positive or negative, this facilitates its interpretation. For example, a level above + 50% reflects a strong upward movement, and below -50% - a powerful bearish trend.
Aroon and ADX
Experienced traders can easily notice that Arun behaves like an ADX mid-range index. However, it should be understood that there are key differences between them.
If you analyze their formulas, you can find that the Aroon indicator uses only one important parameter - time. The upper and lower lines represent the percentage of time between the start of the billing period and the moment the maximum and minimum prices are reached. This means that the Aruna charts can indicate the strength and direction of the trend.
On the other hand, the ADX is not able to measure the direction of movement. To do this, you will need such components as indicators of negative and positive directionality -DI and + DI.
Moreover, ADX uses a more complex formula and an ATR average true range index to “smooth out” a chart that has a built-in lag. The Aroon oscillator responds more quickly to changes in price action compared to ADX, since there are no smoothing or weighting factors in the formula.
Finally
Aroon indicator is an excellent tool that every trader should have in his arsenal. This is a visual representation of market movement that can be easily interpreted to make a decision in accordance with the direction and momentum of the price. It is also possible to significantly increase the chances of a profitable trade if you build a trading technique around Arun in combination with a breakout strategy or any other based on price movement. The indicator very well predicts both trends and periods of consolidation, and also forms signals in combination with other technical analysis tools.