Overview
The Aroon indicator anticipates when a security is changing from an impulsive move to a trading range and vice versa. The indicator was developed by Tushar Chande, who also created the Chande Momentum Oscillator and the Qstick. The indicator displays two plots: (1) Up and (2) Down. The standard period for the Aroon Up and Aroon Down is 25-periods.
Trading Rules
There are some very basic rules that traders can use by analyzing the relationship between the Aroon Up and Aroon Down. There are three basic rules: (1) extreme readings, (2) parallel movement between Up and Down, and (3) crossovers between Up and Down.
Extreme Readings
The indicator has a maximum value of 100 and a minimum value of 0. When the Up reaches 100, it is an early sign that traders are overly bullish and a counter move is likely. Conversely, when the Down reaches 100, it is an early sign that traders are overly bearish and a bounce is in order. Buying and selling these extreme readings works best in markets that are range bound. In trending markets, the Aroon lines will hover around 100 for a number of sessions. This is an indication that the current move is impulsive. During these impulsive moves, traders should add to their positions on any counter moves.
Parallel Movement
When the Up and Down lines run parallel to each other, it is a sign that the security is in a sideways consolidation period. This is often the case before a pending breakout. Traders should wait for the price and volume to increase in the security prior to initiating any new positions.
Crossovers
When the Up crosses above the Down, it is a sign of a potential bullish move. Conversely, a cross of the Down through the Up implies a bearish move is underway. In choppy markets Aroon line crossovers will generate a number of false signals, so traders should use other indicators to confirm the strength of the cross.