Although it’s less commonly known that the MACD, Stochastic or the RSI, this oscillator can be a rather interesting trend indicator. Actually, the Aroon-developed relatively recently in 1995-measures momentum, though it is a fairly good gauge of the strength and quality of trends.
Understanding the Aroon Indicator
Take a look at the daily EUR/USD chart below to see both the Aroon Indicator and the Aroon Oscillator:
The default period is normally 25, but as with the chart above, it has been adjusted to 14. Traders may wish to modify the periods to suit their trading style and method, though for our purposes-as well as my own trading style, 14 works well.
There are two lines on the Aroon Indicator. One is referred to as the “Aroon Up,” while the other is referred to as the “Aroon Down.” Here, the “Aroon Up” is signified by the green line. The great thing about the Aroon, is that it is fairly easy to grasp, and easy to see at a glance too. Note that in the chart above, the “Aroon Up,” has recently crossed the “Aroon Down.” This is a bullish signal. When the reverse occurs- “Aroon Down” crosses the “Aroon Up,” it’s generally considered a bearish signal. When both are parallel to each other, as on the chart during the months of March and part of April, 2013, the market is usually moving sideways or in consolidation mode.
Traders should note the levels of the lines in the Aroon indicator. The scale on the indicator ranges from 0 to 100, and is divided up in increments. The most important levels for traders to keep an eye on, are 0, 30, 70 and 100. In the chart above for example, the “Aroon Up” line (the green one) is clearly at 100, which could indicate a very strong upward trend. Recall that the Aroon is measuring strength. As long as the “Aroon Up” stays at or near the 100 level, the indictor signals continuous bullish strength. Moreover, when the “Aroon Down” line (the purple line) stays below the 30 level...or as close to 0 as possible, the bullish trend is likely intact. When these signals reverse, it could indicate that the bullish trend is running out of steam and might be reversing.
The Aroon gives bearish indications when the signals above are reversed. As with all indicators, traders should seek to match them with concurrent fundamentals. The EUR/USD for example, has some obstacles that may stall the movement higher, so traders want to monitor events that may alter the short term. From the chart above however, the daily flow looks rather positive for this currency pair, but traders should always expect the unexpected.
Additional confirmations on the chart. As with all technical indicators, they work best when used in conjunction with other indicators for confirmation. Traders gain more confidence, and will generally adjust stops as well as limits based upon this data.
On the chart above, we can see that the candlestick on the daily chart has pierced the upper Bollinger Band, which could signal a breakout. We can also see that the Parabolic SAR is suggestive of bullish movement, though we would want to confirm this by other indicators.
As we can also note by the candlesticks circled, there is a bullish engulfing pattern present, which is one of the stronger Japanese candlestick patterns that traders like to see before entering into, or continuing with a long trade.
Also, the RSI is above 50, but not at the oversold levels of 70 or greater. This could be an indication that the market has room to go higher or long.
The Aroon Oscillator
At the bottom of the chart, we can see the Aroon Oscillator. This is an easier indicator to read. It incorporates the data of the Aroon, with the same 0 to 100 scale. In the chart above, we can see that the Oscillator has crossed the center at 50 and is above 70 and moving towards the 100 area. This indicates a strong bullish trend. Indeed, the longer this line remains above 70, the greater indication of continued positive price movement for this currency pair.