Investment decisions are usually considered hit and miss. There are many do’s and don’ts which people preach like never betting more than you can bear to lose. However, there are many tools which can help you make a sound decision that enables you to come out as a winner most of the time. One such tool is the Aroon indicator developed in 1995. Although it is useful, its benefits are directly proportional to how well you use it. Learning to do that is key to making astute decisions.
What is the Aroon Indicator
Aroon Indicator, developed by Tushar Chande in 1995, is a technical indicator which helps you identify when the trend of an investment asset is likely to change. It basically measures the time it takes for an asset to record its high point and low point over a period of time and uses that information to give you an estimate as to the trend that is likely to be. The Aroon up line denotes an uptrend while the Aroon downline denotes a downtrend.
The Calculation and use of Aroon Indicator
The Aroon values are calculated by the formula given below:
Aroon up: ((N-Days since N-day high)/N)X100
Aroon down: ((N-Days since N-day low)/N)X100
‘N’ is usually taken as 25, so it gives you an estimate of an asset based on its 25-day history. The values of these terms fluctuate between 100 and 0. Lower values indicate that the highs and lows were less recent. Higher values, on the other hand, denote more recent highs and lows. While the Aroon Indicator can give a good estimate, it is usually used in conjunction with other tools and practices to get a more detailed result. One such tool is the oscillator which makes the uptrend fluctuate between 100 and 0 and the downtrend between 0 and -100.
When it comes to using the Aroon indicator properly, there are a couple of things you need to understand.
Indicator Movements Around 30 and 70
When the trends attain a value greater than 70 it is an indication that the asset is almost certain to move in that direction. A value lesser than 30 means that the asset strength is pretty low. The area between these two values of 30 and 70 is the region of indecision. You cannot be sure of which direction the asset is going to take when the uptrend and downtrend values are in these regions. But if you see that the downtrend is below 30 and the uptrend is above 70, then the asset is definitely going up.
While the region between 30 and 70 is considered the region of indecision, it can give you accurate information if the two trends crossover in this region. If the uptrend is going up and the downtrend is coming down and the two cross at any point in this region, then the uptrend is strong. The value is thus going up. If the same thing happens but it’s the downtrend that’s going up and the uptrend going down then the reverse is true. So while 30-70 is ambiguous, crossovers in this region give a definitive result.
Aroon Indicator Shortcoming
The Aroon indicator is a great tool to help you identify the trend of an asset and make decisions accordingly. However, you must understand that it is a lagging tool. Lagging tools only indicate the direction of a trend when the asset has already moved in that direction. This means that identifying and reacting against sharp trends is not possible using just the Aroon Indicator. This is why you should rely on other tools as well, like looking out for high volume reverse candles.
When used with the oscillator, the information provided by the indicator is clearer and has lesser confusion. Although it takes away the information of the two trends, it gives a good indication of what decision to take. This is why investors use them together.
The Aroon indicator is quite useful whether you are an investor or a day trader. But its usefulness depends on your identifying how to use it best. The indicator only helps you if you use it well and don’t get confused by its information. Understanding the tool is key if you want to use it for your own benefit.