The Best FX Indicator You’ve Never Seen

08/24/2012 7:30 am EST

Focus: FOREX

Walker England of DailyFX.com describes how he uses an indicator most traders have never even heard of.

Finding the direction of the trend is one of the most difficult tasks designated to any trader. A good example is the AUD/CAD daily chart below. We can see price currently declining over 306 from its June 7 high, which ended a 643-pip advance.

So should a trader look to buy or sell the AUD/CAD? How can we know if the trend has turned? Today we will look at an indicator to help us find the markets current directional bias. Let’s learn about the Aroon indicator.

chart
Click to Enlarge

The Aroon indicator is derived from two lines, Aroon Up and Aroon Down. Both lines run in a marked range between 0 and 100 to help define a currency pair’s strength or weakness. The Aroon Down is depicted as a green line, and as its name suggests, it helps track price in a downtrend. Aroon Up is depicted as a green line and measures the strength of an uptrend.

Traders will watch both lines as they oscillate between 0 and 100, and change their market preference as one line crosses above the other. If Aroon Up is above Aroon Down, the trend is considered down with price expected to go lower. The opposite holds true if Aroon Up sits above Aroon Down. With this in mind, let’s go back and look at our AUD/CAD example.

In the chart below, we again see the AUD/CAD daily chart, this time with the Aroon indicator. We can clearly see that Aroon Down has crossed over Aroon Up. This signal indicates that momentum of the currency pair has shifted and a new downward trend is developing. Traders then will expect price to continue to decline.

This preference would be invalidated if the Aroon Down line crosses the Aroon Up line from above. As the indicator is showing prices moving lower, trend traders should continue to look for fresh selling opportunities.

chart
Click to Enlarge

My preference is to look for continued weakness on the AUD/CAD as long as Aroon Down resides over Aroon Up. One way to trade this market bias is to look for breakouts to lower lows. As indicated in the analysis above, our low for this move resides at 1.0292, and traders can prepare with entry orders if this level is breached.

An alternate scenario includes price moving to higher highs. If this occurs, traders will be notified as the Aroon Up crosses the Aroon Down.

Walker England is a trading instructor with DailyFX.com.

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