The Aroon indicator is used to help traders know when a market is uptrending, downtrending, or is in a range-bound, trendless market.
Knowing when a market is trending is very useful, mainly because trend following technical analysis indicators are profitable during trending markets but cause losses during non-directional markets. Similarly, oscillators are extremely profitable indicators during range-bound markets, but perform very poorly during strong trending markets. The Aroon indicator can show which mode the market is in.
The chart of the Nasdaq 100 shows the different modes of the market and how the Aroon indicator reacts to these different market modes:
Interpreting the Aroon Indicator
When the Aroon Down indicator (in red above) is above the 70 line and the Aroon Up indicator (in greed above) is below 30, then the market is trending downwards.
In contrast, when the Aroon Up indicator is above the 70 line and the Aroon Down indicator is below 30, then the market is trending strongly upwards.
When the Aroon Up and Aroon Down indicator move towards the centerline (50), then the market is entering into a consolidation period.
By varying the period length, the Aroon indicator can give long term indications of trend or short-term indications of trend. By default, the Aroon indicator is 25-periods (shown in the chart above), but a shorter time frame could be 10-periods.
Another version of the Aroon indicator that combines both the Aroon Up and Aroon Down is presented on the next page.
