How to use Aroon Indicator – settings, strategy and formula

Aroon is a trend-following oscillator that gauges the trend strength. The Aroon indicator was developed by Tushar Chande, an Indian trader, in 1995. Chande’s origins played a role in the choice of an unusual name for the oscillator, as the Sanskrit meaning of ‘Aroon’ is ‘the first ray of the morning sun.’ This article covers the Aroon indicator in detail, describing its features, trading signals, and the use of the tool in real trading. 

The article covers the following subjects:

Aroon indicator definition

The Aroon indicator is used in the forex trading and trading binary options to identify the direction of the price movement, measure the relative strength of the trends, define local highs and lows, and therefore, obtain trading signals.

The Aroon determines the changes occurring in the uptrend or downtrend, whether they strengthen or weaken within a particular period.

How Aroon Indicator works

To use the Aroon indicator efficiently, one should understand how this oscillator works.

The Arron indicator is composed of two lines.

Aroon is at the bottom of the EURUSD chart. The yellow line presents the Aroon-up by default; the purple one – the Aroon-Down.

As with any oscillator, these lines are moving within a limited range. In the case of Aroon, the indicator moves between 0 and 100. The Aroon-Up line shows the trader on a 100-point scale the number of periods (minutes, hours, or days, depending on the timeframe) that have passed since the absolute high occurred during a particular period. And the Aroon-Down, respectively, shows the number of periods that have passed since the formation of the lowest price in the chart.

Aroon Indicator Formula Explained

Calculation formula:

  • Aroon-Up = [(number of periods) – (number of periods since the High)] / (number of periods) * 100%.

  • Aroon-Down = [(number of periods) – (number of periods since the Low)] / (number of periods) * 100%. 

For example, if you perform calculations in the daily chart and take the default period of 14 days, and the high occurred six days ago, the Aroon-Up will show the following value: 

((14-6)/14)*100 = 57,

Now that you understand how the Aroon indicator works, you can guess that when the newest high is formed during the current trading day, Aroon-Up shows the value of 100. In a continuous uptrend, the Aroon-Up value will be 100, and in the Aroon-Down – 0, respectively.

Best setting for Aroon indicator

The Aroon indicator can be used on different platforms. Let us explore the Aroon settings in the most popular trading terminals, MetaTrader 4, MetaTrader 5, and the LiteFinance online terminal.

Aroon MT4

MetaTrader 4 doesn’t have the Aroon in the standard indicator list. But you can download the indicator for free. You can find different versions of the Aroon in the MQL library.

I will demonstrate the Aroon settings on the example of the classic version that you can download via this link.

Paste the downloaded file into the “Indicators” folder and restart the terminal. After restarting, it will appear in the list of available indicators. You can read more about the procedure for installing various technical analysis tools in MT in my article “Bollinger Bands Indicator in forex Explained.”

To add the Aroon indicator to the chart, enter the Insert menu and click on the Indicators tab. Go to the Custom section and choose Aroon in the list.

When the indicator is added, you will see the settings. If you click on the OK button, the indicator with the default parameters will be added to the chart.

You can specify the period of the Aroon lines in the Inputs tab. The default period is 14. With such a period, the indicator identifies short trending movements but signals a trend reversal on most corrections.

If you want to trade long-term trends, you should increase the period to 25-30. 

In the Colors tab, you can choose the colours of the indicator lines. By default, the lines are yellow and blue. I would replace yellow with red.

In the Levels tab, you can adjust the overbought and oversold levels. The default values of 30% and 70% are considered optimal.

You can adjust the timeframes to display the indicator in the Visualization tab.

The above figure displays the Aroon indicator in the price chart. The red line is Aroon-Up, the blue one Aroon-Down.

Aroon MT5

In the MQL5 technical analysis tools database, you can find several versions of the Aroon indicator for Metatrader 5. I used the classic version. The Aroon charts can be downloaded via this link.

All the rest is similar to installing the indicator on the MT4. You can follow the guide from the previous section.

If you have done everything correctly, the Aroon indicator with the default parameters in the MT5 looks like the one in the above chart. The green line is the Aroon-Up, the red one – the Aroon-Down.

Aroon in the LiteFinance online terminal

You can also use the Aroon indicator in the LiteFinance online terminal.

To add the Aroon indicator to the chart, click on the Indicators tab.

Choose Aroon in the indicators list.

The indicator with the default values looks like the one above.

The settings have two tabs, Parameters and Style. The Parameters tab provides the period setting (the default length is 14) and the number of decimal places analysed by the algorithm.

In the Style tab, you can set the colours for the Aroon-Up and Aroon-Down lines.

Difference between Aroon oscillator and Aroon-Up/ Aroon-Down lines

In addition to the classic Aroon indicator, there is a version with one line – the so-called Aroon oscillator. You can download the Aroon oscillator via this link.

Aroon oscillator line indicates the difference between the readings of Aroon-Up and Aroon-Down. The tool helps one define the trend stages (beginning, peak, and end); it also signals the start and the end of the price sideways movement. The above Aroon chart displays the classic indicator in the bottom window and the oscillator above. 

The oscillator sends clear and straightforward signals. Traders watch for zero line crossovers to signal potential trend changes. When the oscillator line goes from the negative zone into the positive one, it is a buy signal; a sell signal appears when the line goes from the positive zone to the negative one. If the Aroon oscillator readings are in the range of 40 -100, it indicates a bullish trend; if the readings are in the zone between -40 and -100, there is a clear bearish trend. 

How to read Aroon indicator signals?

Let us discuss the Aroon trading signals, which are quite profitable in the forex market as well as in trading CFDs, stocks, binary options. The application of the Aroon indicator is based on reading several signals.

Identification of the trend direction

The trend is defined according to the location of the lines relative to each other at a level close to 30% and 70%. In an uptrend, Aroon-Up rises above 70% and at times can reach 100%. In a downtrend, Aroon-Down, accordingly, falls below 30%, periodically reaching 0%.

Let us study the examples below to understand better how the Aroon signals work.

The green zone marks an uptrend in the XAUUSD price chart, and the red zone marks the following bearish correction. Note that the yellow line is above the green horizontal line at 70% during the bullish price movement. The purple line is below the red horizontal line at 30% most of the time.

Lines crossovers

The primary Aroon signal is the crossovers of its lines.

When the Aroon-Up line goes above the zone of 30% and at the same time crosses the descending Aroon-Down from the bottom up, it is a buy signal. A new uptrend usually starts at this moment, giving a good entry point for a long position.

The red horizontal line marks level 30% in the EURJPY price chart. The blue circle marks the point where the Aroon-Up crosses the Aroon-Down line from bottom to top. As you know, the crossover occurs immediately after the indicator line goes above the zone of 30% at the moment of the bullish trend’s inception.

One can use this signal both to enter long trades and to calculate the binary options expiration period. For example, if there is still a lot of time left before the contract expiration, then this signal in quite long timeframes will be a good confirmation that the price will move up for a relatively long time.

The Aroon sell signal emerges when the Aroon-Down, going outside the 30% zone, crosses the descending Aroon-Up from the bottom up.

The above Aroon chart shows a good sell signal. The green line marks level 70%. The blue circle marks the moment when the red Aroon-Down line crosses the blue Aroon-Up line upside. This signal means that a new downtrend starts in the market.

Trend stages

The Aroon chart indicator readings provide quite accurate information about the direction of the price movement and the strength of the ongoing trend, the stage of the trend development.

If Aroon-Up:

  • higher than 70% – a strong bullish trend;

  • 50-70% – growing bullish trend;

  • 30-50% – the trend is exhausting;

  • lower than 30% – buyers are no longer interested in driving the price up.

If Aroon-Down:

  • higher than 70% – bearish sentiment dominates the market;

  • 50–70% – bearish trend is strengthening;

  • 30–50% – the bearish trend is exhausting; however, buyers have not yet taken over the initiative;

  • lower than 30% – the downtrend has finished.

Lines move in parallel

When Aroon lines are moving in parallel, traders don’t usually consider it as an entry signal. Most commonly, the parallel movement of the lines signals price consolidation, which is often followed by the price breakout.

Frequent crossovers

Frequent crossovers indicate a balance of supply and demand, which usually results in a sideways trend or trading flat.

Aroon indicator strategies

Well, having studied the signals provided by the Aroon indicator, let us explore popular trading strategies.

Breakout Trading Strategy

This Aroon indicator strategy is based on entering trades when the trend direction changes sharply.

I have already mentioned that a parallel movement of the Aroon-Up and Aroon-Down lines signals the price consolidation, which will inevitably be followed by a new price breakout. So, to multiply your investment, you expect a breakout and enter a trade in the direction of the new trend.

The strategy is based on the following steps:

  1. Define consolidation.

  2. Expect the Aroon breakout signal (the lines crossover, followed by the crossing of the central line)

  3. Expect the signal confirmation to make sure that the Aroon lines crossover is not a false signal. For example, a confirmation could be the breakout of the channel borders.

  4. Enter a trade in the breakout direction.

Let me explain this Aroon indicator trading strategy on the example of the BTCUSD price chart.

The grey zone in the Aroon chart marks the period when the indicator lines are moving in parallel, which signals the market is trading flat. Next, the Aroon-up line breaks through the central line and crosses the Aroon-Down from bottom to top. At the same time, the price chart breaks out the upper channel border, marked by the purple horizontal line. The breakout bar closes above the channel. Therefore, we can safely enter a long trade at the opening of the next bar.

Trend Strength Strategy

When the trend is strong, the Aroon indicator lines remain close to the highest levels. Traders often use this feature to make profits.

The strategy suggests entering a trade when lines reach the maximum values; it is 70% for the Aroon-Up and 30% for the Aroon-Down. The trend direction is identified according to the direction of the preceding crossover of the lines. The profit is taken when the centre line is crossed or when the reversal signal, the opposite crossover of the Aroon lines, emerges.

Let us again study the BTCUSD chart. The blue zone marks the section where the Aroon-Up value is around its high for a long time. It means a great potential of the uptrend. Therefore, we follow the trend and hold up the long trade until the centre line is crossed. This moment is marked with the red circle in the chart.

Trading strategy for binary options

Both trading strategies described above can be used in trading binary options. For short-term contracts, the breakout trading strategy will perfectly suit.

The trend strength strategy could be used for long-term contracts. Besides, one should consider the expiration period to close the contract before the trend reverses in the opposite direction.

There is also a trading strategy based on the combination of the Aroon and the EMA. The Put signal appears when the Aroon-Up crosses the Aroon-Down from the bottom up, and the price chart is under the EMA. An opposite signal is when the red line breaks through the blue one downside, and the contract price is above the EMA. 

Aroon indicator vs ADX

Both the Aroon and the ADX identify the trend direction and its strength. They seem to be generating trading signals of the same type. However, the indicators address different sources.

The Aroon indicator chart formulas primarily focus on the amount of time between highs and lows; its lines show the percentage of the specified period between the price extremes. The ADX formula is more complex, including the average true range (ATR). 

So, I won’t say that these two tools are interchangeable. I suppose one could use Aroon and the ADX together to confirm the trading signals in the market action.

How to trade with Aroon indicator

Let me explain an example of employing the Aroon indicator in forex trading as a primary tool to generate entry and exit signals.

The above figure displays the Brent oil price chart. The green point marks the moment when the Aroon-Up goes beyond the median and crosses the Aroon-Down (the purple) from the bottom up. Having received a signal, we open a long position on the next candlestick, the blue line in the chart.

Next, the red line goes up and stays for a long time around the highest values, which means the trend is really strong. So, we hold up the trade until the trend reversal signal appears. The reversal signal emerges when the descending red line breaks through the purple one and goes below the middle line, the red point. The position is closed with a profit. This moment is marked with the green horizontal line in the chart.

Advantages and Disadvantages

The Aroon indicator, like other technical analysis tools, has its pros and cons.

Advantages:

  • It accurately defines overall trends;

  • It doesn’t repaint;

  • It is equally efficient in trading different instruments and for various trading platforms;

  • It provides accurate signals both in long-term and short-term timeframes;

  • It provides good-quality signals provided the settings are correct.

Disadvantages:

  • Signals could be lagging;

  • False signals often appear in the sideways trend or range trading;

  • Signals should be confirmed by other indicators or technical tools.

Which indicator is best combined with the Aroon?

I have already noted that the Aroon signals can well be confirmed by the ADX. These two technical indicators send the same kind of signals but according to different market factors.

There is a trading strategy based on the Aroon and Stochastic used in conjunction. Aroon defines the global trend, and the Stochastic is used to determine a profitable entry point.

Aroon is often used in conjunction with the EMA. According to this trading system, the principle trading signals appear when the Aroon up and down lines cross; the EMA serves as a supplementary tool to confirm signals. You can read a detailed overview of the exponential moving average signals here.

Aroon oscillator trading: Summary

Aroon is a popular indicator of technical analysis used to identify the beginning of the trend and indirectly gauge the trend’s overall strength and the trend exhaustion. The Aroon signals are quite simple and straightforward, so it is a good indicator for beginners. However, Aroon alone can’t provide sufficient information to enter and exit trades. Therefore, it should be used in conjunction with other indicators to verify trade signals and increase the quality of trades. Aroon performs better when trading in trending markets as it sends quite many false signals in sideways trends. For the same reason, the Aroon oscillator will provide more accurate signals in longer timeframes, although it is generally flexible in choosing the interval. To sum up, I could conclude that the Aroon indicator will be suitable for all investors, both newbies and professional traders. 

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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