What the Aroon Indicator Can Tell You About Stock Breakouts

Fear and greed are the ultimate telltale signs of a potential reversal.

When traders get far too greedy, they send stock prices ridiculously higher. When traders get too fearful, they tend to overreact and send stocks too low, too fast.

If we can spot the exact points where traders are too fearful, or too greedy, we always have an opportunity to jump in ahead of the reversal. 

That is, if you pay attention to technical pivot points.

Quite often, we can use Bollinger Bands (2,20), MACD, relative strength (RSI), Williams’ %R, Money Flow (MFI) and even the Chaikin Oscillator. In fact, when all of these indicators align in oversold or overbought territory, we can tell with 80% accuracy where the pivot will happen.

Go ahead and pull up your favorite chart with these indicators on a one-year and two-year chart. You’ll begin to notice that when there’s agreement among these indicators, it’s soon followed by a pivot in the other direction.

But it never hurts to confirm findings even if these agree with other indicators.

The Aroon Indicator

The Aroon Indicator is made up of Aroon Down and Arron Up indicators.

With this took we’re simply waiting for crossovers.

Technically, though, Aroon Up tells us how long it’s been since prices posted a new high within a set period of time. 

According to Fidelity, “If the current bar’s high is the highest within the user defined number of periods before it, then the Aroon Up value is 100. In other words, it is a new high for the period. Otherwise it returns a percent value indicating the time since a new high occurred for the specified period.”

Aroon Down tells us how long it’s been since prices posted a new low within a set period.

“If the current bar’s low is the lowest within the user defined number of periods before it, then the Aroon Down value is 100. In other words, it is a new low for that period. Otherwise it returns a percent value indicating the time since the new low occurred for the specified period.”

While that may sound confusing, let’s look at it in play.

If Aroon Up crosses above Aroon Down, we may soon see a new uptrend.  If Down crosses above Up, a new downtrend may begin.

We can see that in this chart of Adobe Systems (ADBE) for example.

When Aroon Up (green line) crosses above Aroon Down (red line), it’s an indication of a potential new uptrend. When the red line crosses above the green line, it’s an indication of a potential downtrend.

Here’s another way to use this indicator.

If the green line jumps to or above its 80-line, it’s an indication of an overbought situation. 

And if the red line gets to or below it 10-line, it’s an indication of an oversold situation.

While it’s not a perfect indicator by any stretch of the imagination, it’s best to use it as another confirmation tool. Never rely on just one indicator at any time.

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