The Aroon indicator is used to help traders know when a market is uptrending, downtrending, or is in a range-bound, trendless market.
Knowing when a market is trending is very useful, mainly because trend following technical analysis indicators can be profitable during trending markets but may cause losses during non-directional markets.
Similarly, oscillators can be profitable indicators during range-bound markets, but might perform very poorly during strong trending markets. The Aroon indicator can help indicate which mode the market is in.
The chart of the Nasdaq 100 shows the different modes of the market and how the Aroon indicator reacts to these different market modes:
Interpreting the Aroon Indicator
When the Aroon Down indicator (in red above) is above the 70 line and the Aroon Up indicator (in greed above) is below 30, then the market is trending downwards.
In contrast, when the Aroon Up indicator is above the 70 line and the Aroon Down indicator is below 30, then the market is trending strongly upwards.
When the Aroon Up and Aroon Down indicator move towards the centerline (50), then the market is entering into a consolidation period.
By varying the period length, the Aroon indicator can give long term indications of trend or short-term indications of trend. By default, the Aroon indicator is 25-periods (shown in the chart above), but a shorter time frame could be 10-periods.
Another version of the Aroon indicator that combines both the Aroon Up and Aroon Down is presented on the next page.
The Aroon Oscillator is calculated by subtracting Aroon Down from the Aroon Up indicator. It is interpreted as follows:
- Above 50 is considered a strong uptrending market
- Below -50 suggests that the market is trending lower;
- Near 0 typically indicates that the market is in transition and not trending.
The chart below of the mini-Dow Futures contract shows both the Aroon indicator and the Aroon Oscillator:
The chart below of the Gold futures contract shows how the Aroon Oscillator is interpreted:
A decrease of the Aroon Oscillator from above the 50 line showed that the uptrend is consolidating and is reversing direction downward. When the Aroon Oscillator hovers around the zero line over time, then the market was in a directionless period.
When the oscillator moves toward -50 from the zero line, the market is beginning to trend downward. And when the Aroon Oscillator is below -50, then the market is in a strong downtrend.
When the oscillator begins to move upward towards the zero line, the downward trend is slowing down and beginning to reverse direction.
In addition, when the Aroon Oscillator moves higher from the zero line, then the market is moving from a period of non-trending to a period of uptrending.
The Aroon Indicator and Aroon Oscillator can influence traders to when they might apply trending following indicators like Moving Averages (see: Moving Averages) and when they might use oscillator type technical indicators like Stochastics (see: Stochastics).
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