The Aroon Up / Down indicator was developed by the American trader Trushar Chande to determine whether a value is in an upward or downward trend.
What is Aroon Oscillator Indicator?
The Aroon Up / Down Indicator (ARO)is an indicator consisting of two lines. Its “inventor” Tushar Chande wanted to create a possibility to determine the current market phase of the underlying asset under consideration. A trader needs to know whether the value he is trading is currently in an uptrend, downward trend, or sideways market, as different tactics have to be used depending on the prevailing phase. With this goal in mind, the Aroon Up / Down indicator was created. Based on the user’s period length, the indicator looks at how long it has been since the share reached a new high and low within the period under consideration and shows this relative to the total period. Formally, the following results for the Aroon Up line Presentation:
with N = number of days since the last high.
For example, if the stock reached a new high three days ago in the set period of 10 days, this results in a value for the Aroon Up line of 100 * (10-3) / 10 = 70%.
The Aroon Down line results when looking at the low points within the set period:
with N = number of days since the last period low.
This construction shows that both the up and the down the line can only assume values between 0 and 100%. Figure 1 shows the Aroon Up / Down with a period length of 10 candles in the DAX daily chart, including the respective setting options in guidance.
Aroon Up / Down: Interpretation and Application
The period length can be freely selected by the user, with longer time settings serving to indicate longer and larger trends. The indicator is less sensitive to individual days on which the underlying value does not reach a new high or low. On the one hand, this keeps trend traders in the trend for a long time, as short-term consolidation phases are filtered. On the other hand, a real trend reversal is only indicated relatively late. On the other hand, Shorter settings minimize the latter problem but lead to several false signals within a large trend. While the indicator suggests a phase transition, it is only a short-term consolidation within the still intact trend.
Frequent standard settings about the period length are between 8 and 30 periods, whereby extreme areas are also delimited. In guidance, these have been set to 70% and 30%, respectively.
Different conclusions can be drawn from the position of the two lines. The following summary provides a brief overview:
Aroon Upward trend:
- If the Aroon Up line is above the Aroon Down line, there is an upward trend.
- The Aroon Up line should be above the threshold of 70% in the event of an uptrend to indicate a stable/dynamic uptrend.
Aroon Downward trend:
- If the Aroon Up line is below the Aroon Down line, there is a downward trend
- The Aroon Down line should be above the 70% threshold to indicate a stable/dynamic uptrend
Trend change: The crossing of the two lines indicates a trend change.
Neutral market: Indicator values between the extreme ranges 70% and 30% are considered neutral
Aroon Up / Down: Use in trading
The Aroon Up / Down indicator can be used in trading both as a filter and as a direct signal generator. As part of a filter, the indicator is used to decide on the fundamental question of whether the trader should go long or short. An up / down Aroon up / down suggests only take long positions during this time and vice versa. In addition to this possibility, crossing the lines with each other and the extreme areas can be used as direct buy and sell signals. In the standard interpretation, for example, crossing the Aroon Up with the Down line from bottom to top should be interpreted as a buy signal.
Aroon Up / Down: Critical Appreciation
The Aroon Up / Down represents a simple concept to determine the respective market phase and derive suitable signals from the indicator itself. As with all indicators, the Aroon can also be used successfully but is less recommended as the sole decision criterion. The trader is encouraged to experiment with both the period length and the standard interpretation to take advantage of the market.