What is the Aroon Indicator?

The Aroon indicator is a technical indicator used to identify trend changes in the price of an asset, as well as the strength of that trend. In essence, the indicator measures the time between highs and the time between lows over a time period. The idea is that strong uptrends will regularly see new highs, and strong downtrends will regularly see new lows. The indicator signals when this is happening, and when it isn't.

The indicator consists of the "Aroon up" line, which measures the strength of the uptrend, and the "Aroon down" line, which measures the strength of the downtrend. The Aroon indicator was developed by Tushar Chande in 1995.

Key Takeaways:
-- The indicator is composed of two lines. An up line which measures the number of periods since a High, and a down line which measures the number of periods since a Low.
-- The indicator is typically applied to 25 periods of data, so the indicator is showing how many periods it has been since a 25-period high or low.
-- When the Aroon Up is above the Aroon Down, it indicates bullish price behavior.
-- When the Aroon Down is above the Aroon Up, it signals bearish price behavior.
-- Crossovers of the two lines can signal trend changes. For example, when Aroon Up crosses above Aroon Down it may mean a new uptrend is starting.
-- The indicator moves between zero and 100. A reading above 50 means that a high/low (whichever line is above 50) was seen within the last 12 periods.
-- A reading below 50 means that the high/low was seen within the 13 periods.

Formulas for the Aroon Indicator:
Aroon Up= 25 minus Periods Since 25-Period High divided by 25. Multiply by 100.
Aroon Down= 25 minus Periods Since 25-Period Low divided by 25. Multiply by 100.

Arron UP and Aroon Down Indicator Formulas.
How to Calculate the Aroon Indicator

The Aroon calculation requires the tracking of the high and low prices, typically over 25 periods.

-- Track the highs and lows for the last 25 periods on an asset.
-- Note the number of periods since the last high and low.
-- Plug these numbers into the Up and Down Aroon formulas.

What Does the Aroon Indicator Tell You?

The Aroon Up and the Aroon Down lines fluctuate between zero and 100, with values close to 100 indicating a strong trend and values near zero indicating a weak trend. The lower the Aroon Up, the weaker the uptrend and the stronger the downtrend, and vice versa. The main assumption underlying this indicator is that a stock's price will close regularly at new highs during an uptrend, and regularly make new lows in a downtrend.

The indicator focuses on the last 25 periods, but is scaled to zero and 100. Therefore, an Aroon Up reading above 50 means the price made a new high within the last 12.5 periods. A reading near 100 means a high was seen very recently. The same concepts apply to the Down Aroon. When it is above 50, a low was witnessed within the 12.5 periods. A Down reading near 100 means a low was seen very recently.

Crossovers can signal entry or exit points. Up crossing above Down can be a signal to buy. Down crossing below Up may be a signal to sell.

When both indicators are below 50 it can signal that the price is consolidating. New highs or lows are not being created. Traders can watch for breakouts as well as the next Aroon crossover to signal which direction price is going.

Example of How to Use the Aroon Indicator:

The attached chart shows an example of the Aroon indicator and how it can be interpreted.
In the chart, there is both the Aroon indicator and an oscillator that combines both lines into a single reading of between 100 and -100. The crossover of the Aroon Up and Aroon Down indicated a reversal in the trend. While the index was trending, prior to the reversal, the Aroon Down remained very low, suggesting that the index had a bullish bias. Despite the rally on the far right, the Aroon indicator hasn't shown a bullish bias yet. This is because the price rebounded so quickly that it hasn't made a new high in the last 25 periods (at the time of the screenshot), despite the rally.
The Difference Between the Aroon Indicator and the Directional Movement Index (DMI)

The Arron indicator is similar to the Directional Movement Index (DMI) developed by Welles Wilder. It too uses up and down lines to show the direction of a trend. The main difference is that the Aroon indicator formulas are primarily focused on the amount of time between highs and lows. The DMI measures the price difference between current highs/lows and prior highs/lows. Therefore, the main factor in the DMI is price, and not time.
Limitations of Using the Aroon Indicator

The Aroon indicator may at times signal a good entry or exit, but other times it will provide poor or false signals. The buy or sell signal may occur too late, after a substantial price move has already occurred. This happens because the indicator is looking backwards, and isn't predictive in nature.

A crossover may look good on the indicator, but that doesn't mean the price will necessarily make a big move. The indicator isn't factoring the size of moves, it only cares about the number of days since a high or low. Even if the price is relatively flat, crossovers will occur as eventually a new high or low will be made within the last 25 periods. Traders still need to use price analysis, and potentially other indicators, to make informed trading decisions. Relying solely on one indicator isn't advised.

SOURCE: https://www.investopedia.com/terms/a/aroon.asp