The Aroon indicator is a technical indicator that helps you catch any trend change from the very beginning. Moreover, it shows whether a current price behavior is trending or ranging. Therefore, by using this indicator, a trader can refine their trading strategy to make it more profitable.
A trend is significant in financial trading because all trading strategies work well when they go along with the trend. Conversely, the price can create new swing levels in a ranging market with multiple false breakouts that often make trading difficult.
This is where the Aroon indicator comes into play.
The Aroon indicator shows when a price changes its sentiment from trending to ranging. It determines how long the price holds its momentum after reaching new highs or lows. It is easily visible on the indicator window, with the Aroon Up and Aroon Down lines. Note that, like other indicators, there is a slight lag with the Aroon indicator..
In this article we’ll lead you through a complete guide to the Aroon Indicator, including case studies.
What Is the Aroon Indicator?
The Aroon Indicator is a trading tool that shows whether a price is trending or in a range. If the Aroon Up line crosses over the Aroon Down line, market sentiment is bullish, and when vice-versa, bearish.
In 1995, the Aroon Indicator was developed by Tushar Chande as a part of a family of momentum oscillators. In Sanskrit, Aroon means “dawn’s early light.” As the name implies, the main goal of this indicator is to identify the forming trend.
Traditional momentum oscillators indicate when buying and selling pressures move to an extreme level, from which a reversal is highly expected. Therefore, it is often less profitable to make trading decisions based on indicators like RSI, Stochastic, or ADX. On the other hand, using the Aroon indicator will give you a clearer view of the market sentiment, especially when the new trend will start.
The Aroon indicator is shown in a separate window with two dynamic lines — the Aroon Up and Aroon Down lines.
These two lines fluctuate and show possible direction based on the following conditions:
- When Aroon Up crosses over Aroon Down, the market begins a new uptrend.
- When Aroon Down crosses over Aroon Up, the market begins a new downtrend.
- The uptrend is strong as long as Aroon Up is at a level of 100.
- The downtrend is strong as long as Aroon Down is at a level of 100.
Characteristics of the Aroon Indicator
In this section, we’ll look at a practical example of the Aroon indicator that will help us get a deeper understanding of it.
In the above example, we can see the 15-minute chart of BTC/USDT, where the Aroon indicator is shown in a separate window as it moves from zero to 100. Here, the blue line is Aroon Up, and the red line is Aroon down, as marked in the image.
If you look at the indicator carefully, you’ll see that these lines are shifting their positions frequently. Every position change happens with a crossover, which is the most significant part of this indicator.
Later on, we’ll look at a current price chart based on where the Aroon Down and Aroon Up are heading.
Aroon Indicator Formula
The Aroon indicator calculation focuses on high and low prices over a given period. The primary indicator formula is as follows:
- Aroon Up = [(period specified − number of periods since the highest high)/period specified] x 100
- Aroon Down = [(period specified − number of periods since the lowest low)/period specified] x 100
According to the Aroon calculation, the Aroon Up measures how long buyers hold their positions since the price recorded a new high within the period specified. Its value will reach 100 once the current candle’s high is the highest. Otherwise, it will return to the percentage value pointing out the time since a new high occurred.
On the other hand, Aroon Down measures how long sellers hold their positions since the price recorded a new low within the period specified. Its value will reach 100 once the current candle’s low is the lowest. Otherwise, it will move to the percentage value pointing out the time since a new low occurred.
The primary period of this indicator is 14, but traders can easily change this according to their trading style.
How To Read the Aroon Indicator
The Aroon Indicator is available for most trading platforms, such as TradingView. Like other momentum-based indicators, it is displayed in a separate window below the price chart.
So far, we’ve talked about how this indicator can show whether a price is trending or ranging. However, like other indicators, there is no guarantee that the Aroon indicator will show a confirmed movement. Traders should know how to best use this indicator by reading it correctly.
The Aroon indicator oscillates between 0 and 100, where a level of 70 to 100 is considered as a trending market, and 0–30 is regarded as a ranging market.
In this section, we’ll use a step-by-step approach to analyze a digital asset with the Aroon indicator.
Step 1: Find the Crossover
When the Aroon Up moves above the Aroon Down, it indicates that buyers have become stronger than sellers. They are already starting a bullish trend.
The above image shows Bitcoin’s price moving higher as soon as a crossover occurs in the Aroon indicator. The price rejects the bears at the $48,000 support level, and starts a bullish trend that takes the price straight to the $59,000 level.
Step 2: Find the Strong Trend
In step 1, we’ve seen how a bearish trend shifts to bullish, but it is not enough to consider it valid. We need to wait for the Aroon Up to approach 100 before we can validate the crossover. Remember that Aroon Up will reach 100 only when the price creates a new swing high.
In the above image, we can see the same Bitcoin chart. After the crossover, the Aroon Up reaches 100 and the price starts to move higher, indicating that the bullish trend is strong.
Step 3: Find the Reversal
When the Aroon Up reached 100, the bullish trend became strong.
But how long can it be sustained?
The bullish trend will remain strong as long as the Aroon Up’s value stays between 70 and 100. Later on, if the Aroon Up drops down and crosses below the Aroon down, the bullish trend will start to lose momentum.
Here we can see that the Bitcoin price is moving up by creating higher highs while the Aroon Up remains between 70 and 100. Once the Aroon Up moves below the Aroon Down, the price shifts its direction from bullish to bearish.
It is an indication that buyers are losing their momentum, and traders should close their buy positions or take some profits.
The same market sentiment is applicable to the bearish market, where a strong price direction is set by the following conditions:
- Aroon Down crosses above Aroon Up = bearish trend is forming
- Aroon Down is between 70 and 100 = bearish trend is strong
- Aroon Down crosses below Aroon Up = bearish trend is over
In the above example, we can see how the Aroon indicator works as a bearish price. The trend shifts its direction once the Aroon Down moves above Aroon Up and reaches 100.
Later on, the trend becomes weaker once the Aroon Down moves below Aroon Up, and the price starts to move higher.
Indicators Best Paired with the Aroon Indicator
The Aroon indicator has all the necessary qualities to work as a strong price barometer, but it is not wise to rely on this indicator alone.
In financial trading, we anticipate price movement based on multiple calculations. When the probability is high, the price has a higher chance of following the direction. Therefore, we can stack the odds in our favor when we combine multiple indicators based on their performance.
It is not logical to simply use any random indicator with Aroon because there is no guarantee that together they will work or be profitable.
Based on the previous performance and backtesting, Aroon indicators work well with the following indicators.
Moving Average (MA) shows the average price of a specified period’s candles. Therefore, when the price moves above 20 EMA (Exponential Moving Average), we can consider the underlying trend to be bullish.
In the meantime, if the Aroon indicator shows the same price direction, we can consider the trade valid.
The above image shows that the price rejects a dynamic 20 EMA while Aroon Down is at 100. Therefore, the price comes down from $50,000 to $31,000 in a single swing.
The Aroon indicator works well with MACD. When MACD and Aroon provide the same direction, you can consider the trend direction as strong.
Let’s look at an example below.
In the above image, the Aroon Up is bullish at 100, while the MACD histogram is bullish and making new highs. As a result, the price continues the bullish pressure by creating new swing highs.
Later on, the bullish sentiment weakens once the MACD histogram and the Aroon indicator show a bearish signal together.
Price action traders make trades based on price behavior, support/resistance, and indicators. Therefore, if you want to make a buy trade based on the price rejection from any dynamic or static support level, you can use the Aroon indicator as a confirmation of the entry.
First, find the price direction based on your price action strategy and wait for the Aroon indicator to confirm the signal. If Aroon Up shows a buy signal, enter the trade.
The above image shows that the Aroon Up displays a buy signal by moving to 100. On the next day, the price moves lower and rejects sellers at the event level. As a result, the price moves up with strong bullish pressure.
How Reliable Is the Aroon Indicator?
There is no indicator in the world that will guarantee you a 100% profit. Moreover, any trend-following strategy works well when the price is reaching new highs or lows. On the other hand, in a volatile market, any reversal trading strategy works well.
The strength of the Aroon indicator is that it works well in both trending and ranging markets. However, this tool can also generate profitable signals when the price is moving within a trend. It also indicates the price range where traders should stop trading, and wait for the price to continue its momentum.
The significance of the Aroon indicator is that it focuses on time relative to price, not just on the price itself. In cryptocurrency trading, breaking the near-term high or low is not enough to consider a trend strong. If a price holds its momentum after reaching new highs/lows, it will likely establish another high/low.
Overall, the Aroon indicator is reliable and effective in any crypto asset, but you have to use it with other indicators like MA or MACD. On the other hand, you can use this indicator along with your trading strategy to make it more reliable.
Limitations of the Aroon Indicator
Like other technical indicators, Aroon has some limitations. It often provides false signals due to fundamental releases or economic uncertainty. The Aroon indicator is not a complete solution for trading.
The main drawback of this indicator is its strength on-trend. When the Aroon Up or Down line reaches a level of 100, we consider the trend as strong, which is not correct all the time.
In the above image, the price fails to move higher even though Aroon Up reaches 100.
Another drawback is the timing. Most indicators are lagging in nature, so they may provide signals after movement happens.
Any indicator is reliable once you understand all its elements and know how to predict a price’s movement by combining that indicator with other indicators.
The Bottom Line
Using the Aroon indicator can be very lucrative in cryptocurrency trading. It has the capacity to show both ranging and trading behavior of the market, which makes it unique.
However, just as with other indicators, there are some limitations. Therefore, traders should follow a strategy using the Aroon indicator with money management rules in order to get the maximum output.