Determining the direction of the trend of an asset is one of the most important, yet most difficult, elements of analysis traders must perform. The Aroon indicator comprises two lines, an Aroon up line and an Aroon down line. Learning how to interpret these two lines can help you form a trend directional bias, and in turn, help you decide when to sell stocks.
The Composition of the Aroon Indicator
The two lines that comprise the Aroon indicator move between an upper 100 and a lower zero limit. The first line, the Aroon up line, is normally red by default. The second line, the Aroon down line, is normally green by default. The positions of the Aroon up and the Aroon down lines relative to each other can indicate that price is in a downtrend or an uptrend.
What the Aroon Up and Aroon Down Lines Show
The Aroon up line is formed using a calculation that involves the amount of time that has passed between the current price and the highest price, within the time frame you are using. The Aroon down line is similar, but formed using a calculation that uses the lowest price within the time frame you are using. The Aroon up line is designed to track the price of an asset in an uptrend, so if it is above the Aroon down line it indicates price is trending upward. Conversely, The Aroon down line is designed to track the price of an asset in a downtrend, so if it is above the Aroon up line it indicates price is trending downward.
Using the Aroon Indicator
You can use this inferred direction to help you sell stocks. The point at which the green Aroon down line crosses above the red Aroon up line is the point at which the indicator suggests price is switching from an uptrend to a downtrend. Therefore, when this crossover takes place you could sell the stock you are analyzing, and theoretically enter short at the beginning of a downtrend.
Be Aware of the Aroon Indicator's Limitations
Technical indicators are based on historic price action. Just because the price of an asset has moved in a particular way in the past does not mean it will do so in the future. This means using the Aroon indicator to signal sell entries is not 100 percent reliable. One way to increase the reliability of the indicator is to increase the time frame on which you are analyzing the stock. An Aroon indicator cross on a daily time frame, for example, will generally produce more reliable sell signals than an Aroon indicator cross on a five-minute time frame.
Samuel Rae is an experienced finance journalist whose work has been published across a range of different sites and publications in the financial space including but not limited to Seeking Alpha, Benzinga, iNewp, Trefis and Small Cap Network. He holds a BSc degree in economics.