Aroon indicator is one of the best indicators to identify whether a stock is trending as well as for determining the strength of the trend. Let’s see how.
But first, the basics.
Decoding Aroon Indicator
Typically, indicators usually focus on the price of a stock relative to time. But Aroon is unique, as it mainly focuses on time in relation to the price of the stock. Aroon indicator consists of two distinct indicators called as Aroon Up and Aroon Down.
- Aroon up measures the number of days since price had recorded an ‘N’ day high.
- Aroon down measures the number of days since price had recorded an ‘N’ day low.
Typically, ‘N’ is 14 days.
The orange line in figure below is Aroon Up while the blue line is Aroon Down.
High and Low Values of Aroon Indicator
Whenever the values of Aroon Up or Aroon Down are high, it indicates that a more recent high or low was formed. For example,
- If the stock made a new 14-day high, the value of Aroon Up will be 100.
- If there was no new high within past 14 days, value of Aroon Up would be 0.
- Typically, any reading of above 50 for Aroon High implies that a new high was formed in the past 7 days.
Aroon Down can also be interpreted in the same manner.
- If value of Aroon Down is 0, no new low formed in past 14 days,
- If value of Aroon Down is 100, new 14-day low was formed
- If value of Aroon Down is 50 or more, new low was formed in past 7 days.
How to Use Aroon Indicator In Trading
Aroon indicators can be used for predicting the trends as well as for identifying bullish and bearish moves.
#1 Trend Continuation
- If the value of Aroon Up is above 70 during an uptrend, it means that the trend would continue to be strong.
- If Aroon Down is above 70 during a downtrend, it means that the trend would continue to be strong for some more time.
The figure below shows Aroon Up remaining above 70, and the uptrend remaining strong.
#2 Identifying Consolidation and Correction Period
Aroon Indicator can be used for identifying consolidations and for determining the correction periods.
- Whenever both Aroon Up as well as Aroon Down remain below 30, it is called as a consolidation phase. So, traders can use Aroon indicator for exiting trades when the stock is moving sideways in order to concentrate on other stocks that are trending.
- When a stock is in an uptrend and the Aroon Up moves below 50, it implies that the current uptrend has lost the upward momentum.
- Whenever value of Aroon Down goes below 50 during a downtrend, it means that the momentum of the current downtrend is lost.
#3 Bullish Bias
Bulls have an upper hand when value of Aroon Up is more than 50 and Aroon Down is less than 50. This indicates that there is more inclination towards forming new N-day highs when compared to lows. Bulls are even more pronounced when the Aroon Up is more than 70 and Aroon Down is less than 30 during uptrend.
#4 Bearish Bias
Bears are said to have an upper hand whenever value of Aroon Down is more than 50 and Aroon Up is less than 50. This is especially true when Aroon Down is more than 70 while Aroon Up is less than 30 during a downtrend.
The figure below shows a chart with bullish and bearish moves that can be predicted using Aroon Indicators.