The Aroon oscillator is a step up from the Aroon indicator, extending its functionality to enhance the decision-making of traders, so here’s an overview.
The Aroon oscillator uses elements of the Aroon indicator to show the strength of a trend and how likely it is set to carry on for. It works by subtraction, taking the down value away from the upper value. The Aroon up amount shows the size of the uptrend and Aroon down indicates the size of the downtrend.
- “Aroon up” is worked out like this:
((number of periods) – (number of periods since greatest peak)) / (number of periods) x 100
This means that it works out how long it has been since the price hit its latest peak, and it turns this into a convenient percentage.
- “Aroon down” is worked out like this:
((number of periods) – (number of periods since lowest low)) / (number of periods) x 100
“Aroon down” does the opposite, of course, expressing how long it’s been since the price hit its most recent low.
If you set the period for the Aroon oscillator to 14, (so the calculation uses price information for the most recent 14 candlesticks) and the latest peak was seven candles (or periods) ago, the “Aroon up” amount would be 50 [(14 – 7) / 14 * 100]. If the most recent low was three candles ago, the “Aroon down” value would be 79 [(14 – 3) / 14 * 100].
That would give the Aroon oscillator a value of -29 (50 – 79).
Aroon Oscillator Examples
Example #1
The usual setting for the period of an Aroon oscillator is 14, which means it’s set to use price information from the last 14 candlesticks.
This kind of setting would most likely suit a day trader. The Aroon oscillator keeps traders appraised of the prevailing trend (if there is one) and how potent it is. This can help people who use trend-following approaches to better appraise the potential for trades.
Example #2
A weekly chart of the S&P 500 with an Aroon oscillator period setting of 200 would best suit a longer-term trader, maybe a retired person who wants to hold positions open for a significant amount of time.
Setting the period to 200 gives us an overview of trend information from the previous 200 weeks, so the downtrend that was precipitated by the financial crisis would have gone on right up to 2011. The uptrend through the start of 2018 looked strong (hitting +100 a number of times) before falling back to +50 following February’s correction.
Example #3
Trend-followers with a very long-term approach to trading may find the Aroon oscillator suggests carrying on with long stocks
The setting which uses trend info from the past 200 15-minute periods (the most recent 50 hours that the asset was being actively traded), is most pertinent for those who will be holding positions for anything from several days up to several weeks.
In this instance, the Aroon oscillator does a fairly decent job of finding trends before they happen. It was right on the money about the uptrend in stocks that came in the latter half of January 2018 and it also caught a slow-down and subsequent about-face for the trend prior to the correction that happened at the start of February 2018.
Interpreting the Outputs
With the Aroon oscillator, anything above zero indicates a present uptrend, while anything less than zero points to a present downtrend. If there’s a cross above the zero line this may point to the start of a new uptrend, and a cross below the zero line may point to the start of the latest downtrend.
The Aroon oscillator is usually shown as a bar chart distribution. Levels that range from +40 to -40 (on a +100 to -100 scale) could suggest a consolidating market without a particularly strong trend in either direction.
Conclusion
As with any technical indicator, you shouldn’t be using the Aroon oscillator instead of doing technical analysis based on price. It should only ever be an additional factor that feeds into your usual practice. The Aroon oscillator is good for helping you spot trends but don’t rely on it exclusively. You should adjust the setting in relation to your expected trading horizon and the time compression of the chart you use the most (5m, 30m, daily, and so on).
If you trade using the daily chart and plan to hang onto positions for months, go for a setting of 25 or more. When you trade off the 5-minute chart and plan to hold positions on an intraday basis, go for a setting near 14. Too low a period will swamp it with noise as the range of possible value readings get compressed.
