The AROON was developed by Tushar Chande in 1995. The system should be used originally to determine whether a share / index is in a sideways trend or how strong the current trend is.
“AROON” means from the Sanskrit translated: “first light of the dawn”. This name was chosen by Chande, because the AROON was designed to uncover the beginning of a new trend.
The AROON consists of two indicator lines: the AROON-UP (green) and AROON-DOWN (red). Besides there is still the AROON oscillator, a single indicator line which is defined as a difference between AROON-UP and AROON-DOWN. Because AROON-UP and AROON-DOWN oscillate between 0 and +100, the AROON-Oscillator runs from -100 to +100 with the zero line as a signal line.
The AROON-UP is calculated by determining during a given time interval how much time (on a percentage basis) passed between the beginning of the time interval and the point at which the highest closing price appeared during this time interval. If the share reaches new period highs, the AROON-UP is thus with 100. vice versa applies that the AROON-DOWN is with 100 if the share reaches a new period low.
Interpretation of the indicator levels: Chande indicates that values over 75 indicate a strong tendency in the indicated direction. If the AROON-UP dips under 75, this indicates that the current upward tendency has lost the upward momentum. The same is valid vice versa for an AROON-DOWN, which dips under 75: the current downward tendency loses its momentum. If AROON-UP and AROON-DOWN are below the signal line at 75 at the same time this indicates a mostly short-term sideways-trend.
Calculation of the AROON
The AROON serves differently than the system from DM+ and DM- (see DMI) to the statement whether and how strongly (temporally!) a trend is formed. By the two components AROON-UP and AROON-DOWN the indicator is very easily “readable” and runs, besides, in very ordered courses without big disturbing movements.
The AROON is very easy to read and to evaluate:
- First a signal line is defined for the indicator. I personally use a signal line at 75 points, in the literature often lines at 90 points are also used. The area above this line is the so-called signal zone. Actually, only indicator levels in this area are of interest.
- If one of the two trend components rises into this signal zone, the new trend is considered confirmed. This could well be interpreted as a trading signal in the respective indicated direction.
- If the trend component falls through the signal line, this is initially a signal for increased attention. It could be time to check the stop-loss for the engagement.
- If both trend components are below the signal zone, the market moves rather neutral.
The biggest difference between the AROON and the DM+ / DM- is that the AROON shows NO trend strength in the sense of the volatility, but a trend strength in the sense of a temporal component. In the Chart above one recognizes that the DM+ / DM- system indicates very well a trend strength. The advantage of the AROON lies now in the fact that just with mechanical trading systems with clearly defined signal values can be worked, while the trend strength is determined by other instruments. By the quiet course of the AROON a filter is integrated at the same time.
The AROON is well suitable also because of his ability to deliver trend-conformal “reentry” signals
It is often so that the signal-giving component of the AROON breaks shortly under the signal line to penetrate a short time later again into the signal area. These “reentry” signals can be used either for new engagements or, however, ask to hold the engagement. Since these “reentry” signals occur quite frequently, one should not use the break of the line to sell one’s position as long as there is no crossing with the component that is against the trend.
Still another warning at the end: the AROON considered isolated is not suitable for trading systems. He contains no trend strength component (in the sense of the volatility) and the signals from the crossings come relatively late and should eat up a big part of the accrued profit again.