Introduction
The Aroon indicator, which is widely used by traders to identify trends and trend changes in the price of an asset, was created by Tushar Chande in 1995. Chande is a well-known technical analyst and author of several books on trading and technical analysis. The indicator’s name is derived from the Sanskrit word for “dawn’s early light” or “the first light of day,” reflecting its purpose of identifying the beginning of a new trend.
The Aroon indicator comprises two lines, the Aroon up line and the Aroon down line, which measure the strength of uptrends and downtrends, respectively. The indicator is based on the concept that the price of an asset reaches its highest point during an uptrend and its lowest point during a downtrend. The Aroon up line measures the number of periods since the highest high of the asset was reached, while the Aroon down line measures the number of periods since the lowest low of the asset was reached.
Also see: Aroon Oscillator
The Aroon indicator is plotted on a scale of 0 to 100, with a value of 100 indicating a strong uptrend and a value of 0 indicating a strong downtrend. Traders can use the Aroon indicator to identify potential buy or sell signals. For example, if the Aroon up line crosses above the Aroon down line, it suggests that a new uptrend may be starting, and it could be a signal to buy. Conversely, if the Aroon down line crosses above the Aroon up line, it suggests that a new downtrend may be starting, and it could be a signal to sell.
However, it is important to note that the Aroon indicator is not always accurate and should be used in conjunction with other technical analysis tools to confirm potential buy or sell signals. Moreover, it may be more effective in identifying trends in longer-term charts rather than short-term charts.
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Computing the Aroon Indicator
The Aroon indicator is calculated using two formulas: one for the Aroon up line and one for the Aroon down line.
The formulas to compute are:
Aroon Up = ((Period - Periods Since the Highest High)/Period) x 100
Aroon Down = ((Period - Periods Since the Lowest Low)/Period) x 100
Where:
- “Period” is the number of periods (usually days) that you want to use for the Aroon calculation.
- “Periods Since the Highest High” is the number of periods since the highest high of the asset was reached within the Period.
- “Periods Since the Lowest Low” is the number of periods since the lowest low of the asset was reached within the Period.
In order to calculate the Aroon Up, you need to first determine the number of periods since the asset’s highest high within the period. Subtract that number from the period, divide the result by the period, and then multiply by 100 to get a percentage.
Similarly, to calculate the Aroon Down, you need to determine the number of periods since the asset’s lowest low within the period. Subtract that number from the period, divide the result by the period, and then multiply by 100 to get a percentage.
Once you have calculated the Aroon Up and Aroon Down, you can plot them on a chart and use them to identify trends and potential buy or sell signals. It is important to keep in mind that the Aroon indicator is most effective when used alongside other technical analysis tools to confirm potential buy or sell signals.
The importance of Aroon Indicator in technical analysis
The Aroon indicator is a crucial tool in technical analysis as it enables traders to recognize trends and potential trend shifts in an asset’s price. By examining the Aroon up and down lines, traders can gain insight into whether the price is trending up, down, or sideways. This knowledge is essential to make informed trading decisions and capitalize on market shifts.
Here are some reasons why the Aroon indicator is significant in technical analysis:
Identifying trends
The Aroon indicator can help traders identify whether an asset is in an uptrend or downtrend, which can aid in making trading decisions. For example, when the Aroon up line is above the Aroon down line, it implies that the asset’s price is in a strong uptrend.
Spotting trend changes
The Aroon indicator can assist traders in identifying potential trend changes, which can be beneficial in exiting or entering trades. For example, if the Aroon up line crosses below the Aroon down line, it indicates that the uptrend may be weakening or reversing.
Confirmation tool
he Aroon indicator can serve as a confirmation tool for other technical indicators. For example, if the Aroon up line is above the Aroon down line, and the moving average is trending up, it can provide additional confirmation of a bullish trend.
Versatility
The Aroon indicator is adaptable to different time frames and assets, making it a versatile tool for traders.
Overall, the Aroon indicator is a valuable tool for technical analysts who want to identify trends and potential trend changes in an asset’s price. However, like all technical indicators, it should be used in combination with other tools and analysis techniques to make informed trading decisions.
Tushar Chande’s suggestions on how to use the Aroon Indicator
Tushar Chande, the developer of the Aroon Indicator, shared his insights on the various ways traders can productively use this indicator for trading. Here are some of his recommendations on how to use the Aroon indicator:
Identify trends
By analyzing the Aroon up and down lines, traders can determine whether the asset is trending up, down, or sideways. Identifying trends can help traders make informed decisions about buying, selling, or holding their positions.
Use multiple time frames
Chande recommended using the Aroon indicator on multiple time frames to gain a better understanding of the trend. For instance, traders can use the Aroon indicator on a daily chart to identify the long-term trend and then use it on an hourly chart to spot potential trading opportunities.
Identify potential breakouts
Traders can use the Aroon indicator to identify potential breakouts. When the Aroon up line crosses above the Aroon down line, it indicates that the price may be about to break out to the upside, and vice versa.
Combine with other indicators
To get a more comprehensive picture of the market, Chande advised traders to combine the Aroon indicator with other technical indicators like a moving average or momentum indicator to confirm potential trend changes.
Use as a filter
Chande suggested using the Aroon indicator as a filter to identify potential trades. For instance, if the Aroon up line is above the Aroon down line and the price is above a moving average, it may indicate a bullish trend and offer a potential buying opportunity.
Use as a stop loss
Chande recommended using the Aroon indicator as a stop loss. Traders can set a stop loss at a certain point based on the Aroon indicator, such as when the Aroon up line crosses below the Aroon down line, to limit potential losses.
Also see: How to set up stop loss and take profit levels in trading
Adjust the parameters for different assets
Chande recommended adjusting the Aroon indicator parameters based on the asset being traded. For instance, he suggested using a shorter lookback period for faster-moving assets and a longer lookback period for slower-moving assets. This can help traders get a more accurate picture of the trend for each asset they trade.
Overall, Chande believed that the Aroon indicator is a versatile tool that can assist traders in making informed trading decisions. Nevertheless, he stressed the importance of using the indicator in conjunction with other analysis techniques and tools to get a complete picture of the market.
Advantages & Limitations of the Aroon Indicator
Here are some potential advantages and limitations of using the Aroon indicator in trading:
Advantages
- Identifies trends: The Aroon Indicator is a useful tool for identifying trends in an asset’s price, providing traders with valuable information for making trading decisions. For instance, if the Aroon up line is above the Aroon down line, it indicates a robust uptrend in the asset’s price.
- Provides early signals: The Aroon Indicator gives traders early signals of potential trend changes, which can be beneficial for entering or exiting trades. For example, if the Aroon up line crosses below the Aroon down line, it implies that the uptrend may be weakening or reversing.
- Versatile: The Aroon Indicator can be applied across multiple time frames, making it adaptable to the needs of traders who deal with various assets and time frames.
- Works with other indicators: The Aroon Indicator is compatible with other technical indicators and can offer additional confirmation of trading opportunities.
Limitations
- Inaccuracy: The Aroon Indicator is not always precise and may produce false signals, particularly in choppy or sideways markets.
- Lagging indicator: Since the Aroon Indicator is a lagging indicator, it may not provide signals until after a trend has already started. Consequently, traders may miss trading opportunities or enter trades too late.
- Limited information: The Aroon Indicator only measures the strength of the trend and doesn’t offer information on support and resistance levels or other crucial levels that traders may need.
- Should not be the only tool: Traders should not rely solely on the Aroon Indicator for trading decisions. Instead, it should be used in conjunction with other technical analysis tools and techniques for better accuracy and informed trading decisions.
The Aroon indicator is a valuable tool for traders as it can assist in identifying trends and potential trend changes in the asset’s price. Its versatility enables it to be utilized on multiple time frames, and in combination with other technical analysis tools to confirm trading opportunities.
Although the Aroon indicator can be a valuable asset in trading, it should not be relied upon as the sole factor in making trading decisions. Traders must use other analysis techniques and risk management strategies alongside it to make well-informed trading decisions. It’s essential to remember that past performance is not a guarantee of future results, and trading carries inherent risks.
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