Aroon Oscillator

The Aroon Oscillator enables traders to identify trends and potential trend changes in a security by measuring the time between high and low points, aiding in informed decisions for entry or exit positions

7 minutes


Introduction

The Aroon Oscillator is a technical indicator that is widely used by traders and investors to detect trends and possible trend reversals in financial markets. It was developed by Tushar Chande, an American quantitative analyst and author of numerous books on technical analysis, who introduced the Aroon Indicator in his book “The New Technical Trader: Boost Your Profit by Plugging into the Latest Indicators” in 1995. Later, he created the Aroon Oscillator as a variation of the Aroon indicator.

The Aroon Oscillator ranges from -100 to 100, and a reading above 0 indicates an uptrend while a reading below 0 indicates a downtrend. If the Aroon Up is higher than the Aroon Down, the Aroon Oscillator is positive, suggesting a bullish trend. Conversely, if the Aroon Down is higher than the Aroon Up, the Aroon Oscillator is negative, indicating a bearish trend.

Traders can utilize the Aroon Oscillator to recognize potential trend shifts. For example, if the oscillator has been in positive territory for a prolonged period but starts to move toward 0, it may suggest that the uptrend is losing momentum and that a trend reversal could occur soon. Conversely, if the oscillator has been in negative territory but starts to move toward 0, it may suggest that the downtrend is losing momentum, and a trend reversal could be imminent.

However, like all technical indicators, the Aroon Oscillator should not be relied on solely for trading decisions and should be used in conjunction with other analyses.


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Computing the Aroon Oscillator

The Aroon Oscillator can be computed as follows:

Aroon Oscillator = Aroon Up - Aroon Down

where:

Aroon Up = ((Periods - Periods since highest high)/Periods) x 100;
Aroon Down = ((Periods - Periods since lowest low)/Periods) x 100.

The Aroon Up and Aroon Down are calculated by finding the number of periods since the highest high and lowest low, respectively. “Periods” represents the number of periods being considered, such as days, weeks, or months.

To calculate the Aroon Oscillator, one needs to subtract the Aroon Up from the Aroon Down. The Aroon Up and Aroon Down are determined by counting the number of periods since the highest high and lowest low, respectively.

For instance, if the highest high over the last 25 periods occurred 10 periods ago, the Aroon Up would be 60 (10/25 * 100). Similarly, if the lowest low over the past 25 periods happened 20 periods ago, the Aroon Down would be 80 (20/25 * 100).

As an example, if one is using a 14-day period, the Aroon Up would be calculated by identifying the number of periods since the highest high over the past 14 days, dividing that number by 14, and multiplying it by 100. Similarly, the Aroon Down would be calculated using the lowest low over the past 14 days in a similar way.

Once the Aroon Up and Aroon Down values have been calculated, the Aroon Oscillator can be obtained by subtracting the Aroon Down from the Aroon Up. This provides a single line that oscillates between -100 and 100, indicating the trend’s strength and possible trend changes.



Tushar Chande’s suggestions on how to use the Aroon Oscillator

Aroon Oscillator paired and validated with Stop Loss %-MA indicator

Tushar Chande, the creator of the Aroon Oscillator, has extensively written about how traders can effectively use the indicator for trading purposes. In his book, “The New Technical Trader,” Chande suggests various ways to use the Aroon Oscillator to identify trends and potential trend reversals.

Use the Aroon Oscillator in conjunction with other technical indicators

One approach is to use the Aroon Oscillator along with other technical indicators, such as Moving Averages or the Relative Strength Index (RSI), to validate potential trend changes. According to Chande, no single indicator can provide a complete picture of market conditions.

Look for divergences between the Aroon Oscillator and price

Another technique is to look for divergences between the Aroon Oscillator and the price of the security being traded. Traders should watch out for divergences as they indicate a weakening trend, for instance, if the price is reaching new highs, but the Aroon Oscillator is not.

Use the Aroon Oscillator to confirm breakouts

Traders can also use the Aroon Oscillator to validate breakouts from chart patterns, such as triangles or rectangles. If the Aroon Oscillator is trending in the same direction as the breakout, this could be a sign of a strong trend.

Use multiple time frames

Chande recommends using the Aroon Oscillator on multiple time frames to get a better understanding of the overall trend. It is also essential to consider other analysis methods, including fundamental and sentiment analysis, and market research when making trading decisions.

Use other forms of analysis

In addition to technical analysis, traders may also want to consider fundamental and sentiment analysis when making trading decisions. For example, they could look at news releases, earnings reports, and social media sentiment to help confirm potential trend changes identified by the Aroon Oscillator.

Prevailing market conditions should be given consideration

The effectiveness of the Aroon Oscillator can depend on the market conditions. In a trending market, the Aroon Oscillator can be a useful tool for identifying the strength of the trend and potential trend changes. However, in a range-bound or choppy market, the Aroon Oscillator may provide less reliable signals.

Practice risk management

Moreover, Chande emphasizes the importance of practicing risk management, such as using stop-loss orders to limit potential losses and manage risk. Additionally, traders must consider market conditions as the effectiveness of the Aroon Oscillator can depend on them. For instance, in a range-bound or choppy market, the Aroon Oscillator may provide less reliable signals.

Avoid over-reliance on the Aroon Oscillator

Lastly, Chande advises traders to avoid over-reliance on the Aroon Oscillator and always consider the bigger picture when making trading decisions. Using the Aroon Oscillator in conjunction with other analysis methods can lead to informed trading decisions.

In summary, Chande recommends using the Aroon Oscillator in combination with other technical indicators and analysis methods, practicing risk management, and considering market conditions to make informed trading decisions.


Advantages & Limitations of the Aroon Oscillator

Here are some advantages and limitations of using the Aroon Oscillator in trading:

Advantages

  • Identifies trend changes: The Aroon Oscillator can be used to identify potential trend changes in the short and long term.
  • Simple to use: It is a relatively simple indicator to use, making it accessible to traders of all experience levels.
  • Can be used on multiple time frames: Traders can use the Aroon Oscillator on multiple time frames to identify trends and potential reversals.
  • Can be used in combination with other indicators: The Aroon Oscillator can be used with other technical indicators to confirm potential trend changes.

Limitations

  • Can provide false signals: The Aroon Oscillator can provide false signals, especially in choppy or range-bound markets.
  • Does not provide price targets: Traders must use other analysis methods to determine their profit targets.
  • May be less effective in certain markets: The Aroon Oscillator may provide less reliable signals in a range-bound or choppy market.
  • Does not consider fundamental factors: The Aroon Oscillator is a purely technical indicator and does not consider fundamental factors that can impact the price of a security. Traders should consider other factors, such as news releases and earnings reports, when making trading decisions.

The Aroon Oscillator is a widely used technical indicator that traders can utilize to recognize trend shifts and potential trend reversals in a security. It is user-friendly and can be employed across multiple time frames. By integrating the Aroon Oscillator with other technical indicators and analysis approaches, traders can make informed trading decisions and manage risk adeptly.


While the Aroon Oscillator is a valuable tool for identifying trends and potential trend changes, it’s not without its limitations. False signals can be produced, particularly in choppy or range-bound markets. To make informed trading decisions, traders must also consider fundamental factors such as news releases and earnings reports. To mitigate potential losses, traders should practice proper risk management and utilize the Aroon Oscillator in combination with other analysis methods.


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