Aroon Indicator - Trend Following Tool

Aroon Indicator - Overview

The Aroon indicator anticipates when a security is changing from an impulsive move to a trading range and vice versa. The Aroon indicator was developed by Tushar Chande, who also created the Chande Momentum Oscillator and the Qstick. The aroon indicator displays two plots: (1) Aroon Up and (2) Aroon Down. The standard period for the Aroon Up and Aroon Down is 25-periods. Below are the formulas for the Aroon Up and Aroon Down.

Aroon Indicator Formula

Trading Rules - Aroon Indicator

There are some very basic rules that traders can use by analyzing the relationship between the Aroon Up and Aroon Down. There are three basic rules: (1) extreme readings, (2) parallel movement between Aroon Up and Aroon Down, and (3) crossovers between Aroon Up and Aroon Down.

Extreme Readings

The Aroon indicator has a maximum value of 100 and a minimum value of 0. When the Aroon Up reaches 100, it is an early sign that traders are overly bullish and a counter move is likely. Conversely, when the Aroon Down reaches 100, it is an early sign that traders are overly bearish and a bounce is in order. Buying and selling these extreme readings works best in markets that are range bound. In trending markets, the Aroon lines will hover around 100 for a number of sessions. This is an indication that the current move is impulsive. During these impulsive moves, traders should add to their positions on any counter moves.

Parallel Movement

When the Aroon Up and Aroon Down lines run parallel to each other, it is a sign that the security is in a sideways consolidation period. This is often the case before a pending breakout. Traders should wait for the price and volume to increase in the security prior to initiating any new positions.

Crossovers

When the Aroon Up crosses above the Aroon Down, it is a sign of a potential bullish move. Conversely, a cross of the Aroon Down through the Aroon Up implies a bearish move is underway. In choppy markets Aroon line crossovers will generate a number of false signals, so traders should use other indicators to confirm the strength of the cross.

Charting Example - Aroon Indicator

The below chart is from the recent debacle in Citgroup. Notice how the Aroon Down stayed between 100 and 70 for over three months, while the stock experienced a 50% decline.

Aroon Indicator Charting Example