Pinpointing Changes in Market Direction

06/04/2014 9:00 am EST

Focus: FOREX

This indicator can be used to find the likely direction of a forex pair on several different timeframes, says staff at FXTM.

The Aroon indicator is another from leading market technician, Tushar Chande, who is responsible for a number of books and popular technical indicators used all over the world. Chande designed the indicator back in 1995, and since then, it has been an effective but not so widely used tool among traders (compared to his other indicators).

The indicator consists of two lines, Aroon up and Aroon down, to show market direction and in some respects, bears many similarities with the directional movement index (DMI) by J. Welles Wilder.

Early Light
The term “Aroon” is a Sanskrit word and means “dawn’s early light.” The term obviously refers to the fact that the Aroon indicator is able to signal trend changes early.

The two lines of the Aroon indicator form the basis of any trading strategy when using the Aroon and each line is given a range between 0 and 100.

Aroon up shows how upward strength in the market is being tracked and thus indicates whether the market will be upward moving or downward moving. Aroon down shows downward strength.

The best way to use the indicator is to use it as a type of filter. In other words, longs should only be taken when Aroon up is above Aroon down and shorts should only be taken when Aroon down is above Aroon up.

Oscillator
The Aroon can also be used as an oscillator and to indicate whether the market is trending or range-bound.

During range-bound markets, both Aroon lines, up and down, will be fairly close together and both lines will show low readings.

When Aroon up is above 70, it indicates a very strong trend taking place, while below 50 and the trend is weakening. Any lower than 30 and the market is not likely to be trending at all.

Using this knowledge it is easy to come up with a strategy: Long trades should be entered when Aroon up is above 70 and the position should be reduced when the line drops below 50. If Aroon up drops below Aroon down the whole position can be closed.

The same strategy can just as easily be applied to shorts. That is, when Aroon down is above 70, a short trade can be entered into the market. If Aroon down drops below 50 the position should be reduced and if the line crosses below Aroon up then the whole trade should be taken off.

By the Staff at FXTM

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