The Aroon Indicator is a technical instrument used to measure the trend’s strength and identify the direction of the price change. The indicator consists of two lines ranging from 0 to 100. The crossover of those lines usually points to a shift in the technical sentiment, while their position in relation to each other points to the current direction of the trend.
The tool belongs to the oscillators class of indicators as it indicates waves of the value. However, it has several significant differences due to a mathematical formula based on counting the number of peaks and bottoms during the chosen period. The main idea is that when the market is in an uptrend, prices keep charting new highs and the number of fresh peaks is growing within the period. If the trend’s direction heads south, prices have a larger number of lows, increasing the bearish momentum.
What is Aroon Indicator?
Aroon Indicator is an adjustable technical tool measuring a relative number of highs and lows in the price chart. It consists of two lines - Aroon Up and Aroon Down indicator bullish and bearish performance, respectively. Both lines are ranging from 0 to 100, while values above 50 show the uptrend and values below 50 point to the downtrend phase. The crossover of the lines indicate the change of the momentum as if the number of highs increased during the downtrend, forex traders could expect a bullish retracement if not the complete reversal.
The default period of the indicator is 25 bars (days or hours, depending on the timeframe), however, traders can adjust the period according to individual trading approach. If the trading system is based on a large number of entries, traders can lower the period. Otherwise, a longer-term approach would keen on ignoring short-term fluctuations and require a longer period of the indicator. The best setting for Aroon indicator also depends on a particular asset to trade on and can be different from one currency pair to another.
Unlike other oscillators, the Aroon indicator chart does not have overbought or oversold levels. Actually, designers of the instrument did not care about how far the price could go during a sustainable action. The main advantage of the indicator is to monitor the sequence of lower lows and higher highs as the strength of the trend might be described by this parameter. Sideways ranges usually come together with rare peaks and bottoms, thus, Aroon oscillator will reflect the weak momentum. One of the most useful applications of the method is to find a perfect moment to exit the market after holding a profitable position. Nevertheless, additional indicators might be helpful in terms of determining the depth of a possible retracement, calculate stop-loss and take-profit orders and get entry signals.
Here is a screenshot showing how the Aroon indicator chart looks like:
Aroon indicator formula
As already mentioned above, the key metric for this oscillator is the number of highs and lows within the given period. However, it’s range-bound, and both lines have to be measured in comparison to each other as traders are interested to get the full information about the current trend. Thus, the Aroon Indicator formula has to focus on a relative number of peaks and bottoms for both lines. As a result, traders will know how often the price charts peaks compared to bottoms. The more this ratio is the stronger the uptrend will be. For the downtrend, this condition is the same but opposite as the number of lows will appear more often compared to the number of highs.
Here is the full formula:
Actually, the calculation of Aroon Indicator is simple and can be done manually. The only thing to do is just track lows and highs of the price during the period and calculate the number of periods since the last high and low. Adding those figures into two formulas above will give the immediate result. The main advantage of the indicator attached to the chart is that it gives a visual representation of the resulting numbers.
How to read Aroon Indicator?
Traders can make several conclusions about the current technical sentiment and trend’s direction depending on the position of Up and Down lines, as well as their movement in relation to each other.
Here are the takeaways:
- When the Aroon Up is above Aroon Down, the market phase is bullish;
- When the Aroon Down is above Aroon Up, the indicator shows a bearish trend;
- When the lines cross each other, Aroon indicator signals a change in market conditions;
- A value above 50 shows that the high/low has been seen within 12 last bars;
- A value below 50 shows that the high/low was charted within 13 periods.
Best settings for Aroon Indicator
The only input parameter to change in the Aroon indicator settings is the length or the number of periods used in the calculation. The default period is 14 bars (days, hours or weeks depending on the chosen timeframe). Therefore, before choosing the best settings for Aroon Indicator, it is important to determine what timeframe will be used for the analysis.
Forex traders keen on a long-term perspective would be interested to catch strong trends, ignoring some insignificant price fluctuations. Thus, such a trading approach would need a lower sensitivity of the indicator as traders would not want to react on the smallest shift of the technical sentiment. Lowering sensitivity means enlarging the period. For example, such timeframes as weekly and daily chart might need Aroon Indicator length in the range of 14-34 bars as this period is the best in terms of taking into account all of the price swings. The middle value of the range is 21 bars, which is one of the numbers of the Fibonacci rows. Aroon Indicator with a period of 21 days or weeks is the best period-balanced instrument to reflect trend reversals with the long-term approach.
Intraday and scalping traders, in contrast, would need a much larger number of trading signals because the overall frequency of deals is higher compared to swing trading, for instance. This is why short-term trading methods based on hourly, 30- and 15-minutes charts will require a more sensitive tool to reflect all of the changes in the market sentiment and trend’s direction. In this case, best settings for Aroon indicator length will be in the range of 5-13 bars were 5, 8 and 13 bars are also coming from the Fibonacci row. As a result, Aroon Indicator would have a larger number of crossovers and trading signals, increasing the overall number of entries and trading positions within a given period.
How to use Aroon Indicator in Forex trading?
Forex trading strategy based on Aroon up and down indicator shows better performance when deals are opened in accordance with long-term trends. Reversal signals coming from the indicator could show a moment when a retracement is over and the general trend is likely to continue. By-the-trend crossover will indicate a perfect entry opportunity, while a counter-trend signal will show when it’s time to take profits from a profitable position.
Conditions for long positions
- When the general trend is bullish, traders should wait for a bearish retracement to come to an end;
- Once the Aroon Up (green line) crosses the Aroon Down (red line) from below, open long positions on the open price of the following candlestick;
- Hold the long position until the Aroon Up remains above the Aroon Down;
- When the opposite crossover occurs, close the deal manually at the market price;
- The stop-loss order has to be set below the previous low of the candlestick, which leads to the entry signal.
Conditions for short positions
- When the general trend is bearish, traders should wait for a bullish retracement to come to an end;
- Once the Aroon Up (green line) crosses the Aroon Down (red line) from above, open short positions on the open price of the following candlestick;
- Hold the short position until the Aroon Up remains below the Aroon Down;
- When the opposite crossover occurs, close the deal manually at the market price;
- The stop-loss order has to be set above the previous high of the candlestick, which lead to the entry signal.
If you like this strategy, you might also be interested in this Force Index Indicator
Example of how to use
Sometimes the Aroon chart could be confusing, especially when the price action is volatile and several microtrends change the market’s direction. Forex traders can consider adding other technical indicators to the chart setup to have additional filtering and confirmation of the trading patterns. The main requirement for the second indicator is to have a different approach in terms of the mathematical formula. For example, trend indicators with moving averages might be useful. The widely-used system of Exponential Moving Average and MACD might show possible retracement depth and double-check trading signals coming from Aroon crossovers. Another type of indicators to combine with Aroon oscillator is Bollinger Bands as it delivers additional information about the current volatility, support and resistance levels. Here are several examples of profitable trading using Aroon oscillator with other technical indicators.
Aroon indicator, MACD and EMA
EUR/USD in an obvious downtrend on the daily chart below. The chart setup consists of Aroon indicator, MACD and exponential moving average with the period of 100 days. The first example of the bearish signal from Aroon oscillator comes in line with two other indicators. The daily price failed to break through the EMA 89 resistance, MACD histogram is in the negative territory, both lines have just dropped below 0. The signal is confirmed and the profit taken. However, the second example shows that the bullish crossover of the Aroon Up and Down lines was not confirmed by the MACD indicator, which remained negative. The rate was below EMA 89, so the buy-signal was ignored.
Aroon indicator and Bollinger Bands
Here is the same chart with Bollinger Bands (period 25 days) as a secondary indicator. The first bearish crossover of the Aroon lines was good enough to take the sell-signal as the rate bounced off the BB middle line and remained in the bearish phase. However, the second Aroon crossover, which pointed to a buy-signal was fake as Bollinger Bands was still bearish and EUR/USD did not enter the bullish phase.
The Aroon indicator has an alternative approach to measure the trend’s power and indicate the direction compared to other oscillators. It has a simple mathematical formula, which does not overcomplicate the calculation and trading process. The trading strategy based on Aroon oscillator is flexible and adjustable, traders can take advantage of clear trading signals on different timeframes and many currency pairs. On the other hand, the technical instrument is quite lagging and additional technical indicators would help traders to increase the efficiency of the trading system as well as show attractive entry and exit levels.