S&C - A Time Price Oscillator (Aroon).pdf

Stocks & Commodities V13 (369-374): The Time Price Oscillator by Tushar S. Chande

INDICATORS

A Time Price Oscillator

Technical indicators, and oscillators in particular, measure the behavior of price relative to time. For example, the rate of change oscillator calculates the percentage change in price over a set period. That said, now consider an indicator that reverses the roles of price to time and measures the passage of time relative to price. This article details such an indicator, presenting numerous applications. by Tushar Chande, Ph.D.

A

ll major price trends evolve, both in price and time. A market trading in a sideways trend may begin to advance, turning into an upward trend, forming a series of higher highs and higher lows. Over time the uptrend will mature and move into a sideways trend again, ultimately forming a market top, and then a downward trend will emerge. This new trend, led by lower lows and lower highs, will reach a market bottom and form another sideways trend. During each phase of the trend, money can be made by simply following the trend or by anticipating price changes about a trend. For example, you can design a trend-following method to establish positions in accordance with the major trend. However, you can also use a trading range method, buying at the lower side of a trading range and Copyright (c) Technical Analysis Inc.


selling at the upper side. This would be considered an antitrend philosophy. The key question is: When is the best time to do either? At what point during a market cycle should you expect a trend to begin or end, and when can you accurately estimate that the direction has changed? You can count on the markets changing direction, just as you can count on day following the night. Like the sun, trends emerge, rise to a peak, weaken and fade away. In Sanskrit, aroon is the word for dawn's early light, the first sign of a new day or a change from night to day. Thus, "aroon" is an apt name for an indicator that is sensitive to the beginning of a new trend. This new indicator combines price and time in a way that illuminates the evolution of the price trend, and you can use it to identify periods when trend-following or antitrend strategies are likely to succeed.

THE BASICS OF AROON The simplest definition of an uptrend is a series of higher highs and higher lows. Similarly, the definition of a downtrend is a series of lower lows and lower highs. However, within this definition, prices can evolve in any of a number of ways. The distinct manner in which a trend moves can include a combination of price relationships; for example, traders often compare today's price to some price in the past, such as today's high to a high a number of days ago. Overlooked in this process is the passage of time as a measurable component of the picture. Hence, we can ask this question: How many days have passed since the most recent x -day high or most recent x -day low? To answer the question in trading terms, we can use a breakout criterion and use a fixed period for reference. Say we arbitrarily pick 25 days as our reference period, since this number roughly corresponds to one month of data. We can now define a trend as consisting of a series of higher 25-day highs and higher 25-day lows, or as a series of lower 25-day lows and lower 25-day highs. All that remains is to ask how much time has passed since the most recent 25-day high or low. Consider a market that has made a new 25-day high as of today. In this case, the number of days since the most recent high is zero. Assume that the market has been in a steady uptrend. In this case, it is possible that the number of days since the last 25-day low is 25. Hence, we can quantify this trend on a time scale as follows: Aroonup = 100((Refperiod - #Days Since High)/Refperiod ) Aroondn = 100((Refperiod - #Days Since Low)/Refperiod ) If we pick 25 days as the reference period (Refperiod ), then Aroonup =100((25 - #Days Since 25-day High)/25) Aroondn = 100((25 - #Days Since 25-day Low)/25) When the market makes a new 25-day high, aroonup = 100; when the market makes a new 25-day low, aroondn = 100. When the market has not made a new high for 25 days, aroonup = zero, and when the market has not made a new low for 25 days, aroondn = zero. The formulas for SuperCharts are:

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Remember that the 25-day period was chosen arbitrarily; you can choose any period. We can also define an oscillator simply by taking the difference between the uptrend and downtrend numbers, Aroonosc = Aroonup - Aroondn

USING AROON When you plot aroonup and aroondn in an indicator window below the price chart, you can recognize patterns. The first guideline is the trend shown by the component that has most recently reached a value of 100. For example, in Figure 1, we see the 1995 rally in the interest rates instruments using the June 1995 10-year Treasury note futures contract. The market bottomed in fall 1994 and has rallied since December 1994. In the indicators plotted below the price bars, the darker line is aroonup and the lighter line is aroondn . Aroonup first clicked to 100 in late November, signaling a possible change in trend. The market then made a few 25-day new highs before entering a consolidation period in December. During this time, no new 25-day highs or lows were made; hence, the aroonup line trended lower, toward zero. Aroonup and aroondn moved lower in parallel fashion.



109 108 107

During the uptrend, the Aroonup line remained above the Aroondn line

106 105 104 103

Aroonup hit 100, indicating possible trend change

102 101 100

Aroonup Parallel downward movement indicates a consolidation

99

Bullish signal 100 90 80 70 60 50 40 30 20 10

Bearish crossover D

95

F

M

A

M

FIGURE 1: JUNE 1995 10-YEAR T-NOTE. The first indication of strength occurred when the aroonup line hit 100 in December. Then during the consolidation, both the aroonup and the aroondn lines moved to zero. Next, the aroonup line hit 100 in January and stayed persistently between 70 and 100, indicating a bull trend.

This pattern always signals a consolidation. In addition, the market never made new 25-day lows and as such, aroondn never reached 100, an indication that no significant selling occurred in the market during this consolidation. However, it appeared that in early January 1995, the market was about to form new 25-day lows as the aroondn line crossed over and above the aroonup line. The aroondn line appeared to be headed for 100. But the market rallied to a new 25-day high, signaled by the aroonup line crossing over the aroondn line and moving to a value of 100. This was the real breakout, and prices moved higher. As expected, the aroonup line has remained above aroondn throughout the rally. During the consolidations, the market never made new 25-day lows, and breakouts to new highs with aroondn near zero were good short-term trades. You can see this same pattern in Figure 2, a closeup of the April to May trading period of the June 1995 Treasury note. The price surged above the 106-08 area after a brief consolidation, and simultaneously, the aroondn line was below 30. Note that consolidations are marked by parallel lines forming between aroonup and aroondn . You can observe the same scenario in the June 1995 yen futures contract (Figure 3), when in February, after a brief consolidation marked by parallel lines of aroonup and aroondn , it broke out decisively with aroondn near 30.



FIGURE 2: JUNE 1995 10-YEAR T-NOTE. Here's an example of a successful upside breakout with the aroon up line moving to 100.



FIGURE 3: JUNE 1995 YEN, UPSIDE BREAKOUT. Here's another example of an upside breakout with the aroon dn line below 30.

MORE PATTERNS During consolidations, sharp market moves often occur after aroonup declines below 50. You can see an example of this in the June 1995 yen contract (Figure 4), where a decline of aroonup below 50 preceded a breakdown below the 119.00 level. The same pattern occurred in the June 1995 COMEX gold contract (Figure 5); here, the market broke sharply a few days after the aroonup indicator had declined below 50. A value of 50 for the aroonup indicator simply means that 13 days have passed since the most recent 25-day high, which indicates a loss of upside momentum.



FIGURE 4: JUNE 1995 YEN, FOREWARNING A DECLINE. If the market has been in an uptrend, a decline may be forewarned by the aroon up line declining below 50, as it did here in early May.



FIGURE 5: JUNE 1995 GOLD. Each time the aroon up line dropped below a reading of 50, the price of gold fell.

The direction of the next trend change can be deduced when the aroondn and aroonup lines descend from left to right parallel to one other. The probable direction is in the direction of the lower line. In Figure 6, you can see the June 1995 Canadian dollar contract. During the downtrend, the aroondn line was above the aroonup line. Then the Canadian dollar bottomed and retested the lows. While the market bottom formed, the two aroon lines wavered back and forth. During the second test of the lows, the aroon lines descended from left to right, forming two closely spaced parallel lines. The aroon up line was below the aroondn line, suggesting that the next crossover would be a breakout to the upside. The crossover occurred in early April, near the 71.00 level, and the Canadian dollar moved steadily toward the prior highs. Note again that good breakouts occur when the two lines are far apart, in this case with aroondn below 30.

FIGURE 6: JUNE 1995 CANADIAN DOLLAR. During March 1995, the aroon up line fell in parallel step with the aroon dn line. The crossover of the aroon up line above the aroon dn line signaled a market advance.

The aroon oscillator (aroonosc ), which is the difference between the aroonup and the aroondn , can be used to "meter" the trend strength as well as trade. Returning to the June 1995 gold contract, which was trading in choppy fashion tracing wide swings, the aroonosc showed the strength of the trend on a scale of +100 to -100 (Figure 7), and its zero crossover gave good signals for buys and sells.



FIGURE 7: AROONOSC AND JUNE 1995 GOLD. The oscillator can indicate overbought and oversold market conditions. Crossovers at the zero level can be used to indicate changes in market direction.

AN ECLIPSE If you choose, you can fade† a market when either aroonup or aroondn is in the 100 area. Use good risk control and limit your losses with this strategy, since the trend may not necessarily falter but could continue in a dramatic fashion. Having said that, this strategy would have picked the tops and bottoms in the July 1995 coffee futures contract quite nicely (Figure 8). This strategy is usually early, and you should be ready to reverse to a trend-following position if needed. You could use a separate indicator to determine a trend or anti-trend phase in the market. If the market is trending, then do not fade the trend, and if the market is in a trading range, then fade the trend. This approach is illustrated with the December 1992 high-grade copper futures contract in Figure 9. My other indicators indicated a trend during June, July and August, and then a trading range formed. You could have picked the top and bottom very accurately with the additional risk of resisting the downtrend at two points.



FIGURE 8: JULY 1995 COFFEE. During trading ranges, a reading of 100 by the aroon up line and the aroon dn line can signal overbought and oversold situations.



FIGURE 9: DECEMBER 1992 COPPER. The market entered into a trading range in August, therefore a sell signal based on the aroon up line moving to 100 was warranted.

You can use aroon to focus on the long-term trend. The August 1982 soybeans contract (Figure 10) was in a sideways pattern in May. No sooner had aroonup declined below 50% that a significant downtrend began around the 675 level. It continued in a choppy style all the way down to the 550 area, a megaprofit opportunity. At no time during this decline did aroonup climb above 50. Thus, just by observing the pattern of the two lines, you can keep aligned with the major trend.

FIGURE 10: AUGUST 1982 SOYBEANS. During May, the aroon up declined below 50, forewarning of an emerging bear market.

The same principle can be seen in a shorter time frame using the March 1979 cotton contract (Figure 11). A major top was forming near the 73 area, but it seemed ambiguous. The return rally from a price of 69.00 cents during November had exceeded all retracement targets. However, once the two aroon lines crossed, they never crossed again, and the aroonup line stayed below 50. Thus, if the trend is down, observe the aroonup line for clues, and if the trend is up, observe the aroondn line for clues.



FIGURE 11: MARCH 1979 COTTON. Once the aroon up line crossed below the aroon dn line, the market traced out a series of lower lows and lower highs.

The choppy trading action that occurred for the March 1991 Deutschemark futures contract (Figure 12) shows the same patterns. Note how sharp selloffs occurred after aroonup had crossed below 50. In choppy markets, the crossovers of the two lines, and their movement below 50, seem to lead to swing moves. Note how the rapid rise after the aroondn line declined below 50. Thus, the 12- to 13-day period after forming a new high or low often leads to short-term trading moves.



FIGURE 12: MARCH 1991 DEUTSCHEMARK. A decline below 50 by the aroon up line was followed by a selloff in the market.

A trader would be well served by keeping an eye on aroon, since it signals breakouts. A breakout represents a sudden shift in market fundamentals that may evolve into a big move. Nothing proves this better than the March 1990 orange juice contract (Figure 13). The market had been trending lower into late November 1989. The aroondn line was bouncing between 70-100, while the aroonup line was below 20. It had all the signs of an orderly decline. Yet, overnight, the market gapped upward, and aroonup leaped from 8% to 100%. The aroondn line just barely edged lower.



FIGURE 13: MARCH 1990 ORANGE JUICE. During late November 1989, the price of orange juiced gapped up on the chart and aroon up jumped to 100. The aroon dn then fell below 50, indicating an emerging uptrend.

What did this mean? Was it a one-day wonder or was it actually a market shift? For the next eight days, the market traded choppily, filling the gap. Yet the aroondn line declined below 50%, indicating that a real market shift was under way. This occurred at the 127 area during the first week in December. Clearly, a trader had at least eight days to do something about this potential change. The decline in aroondn below 50 flagged a strong rally. Just 31 trading days later, the orange juice contract was above 200, a move that would have made your mouth water (Figure 14).



FIGURE 14: MARCH 1990 ORANGE JUICE. After the signal detailed in Figure 13, the market traded much higher. The aroon up line stayed near 100, while the aroon dn line rested near zero during the rally.

CONCLUSION Aroon measures how many days have passed since an x -day high or low. During trends, it measures 100, when new x -day highs or lows are being made. During consolidations, it decreases toward zero when x -days have passed without making a new x -day high or low. The uptrend and downtrend lines make useful patterns when they move parallel to one another, indicating a consolidation, and with the crossover of the two lines suggesting future price direction. Sharp corrections tend to occur after 13 days have passed, when aroon values are below 50. The aroon oscillator can provide useful insight into the price plus time evolution of a trend and can be used to trade with the trend, or against it. Tushar Chande is a Contributing Editor for STOCKS & COMMODITIES and holds a doctorate in engineering from the University of Illinois and a master's degree in business administration from the University of Pittsburgh. RESOURCES, READING Chande, Tushar [1995]. "A market bottom pattern for S&P futures," Technical Analysis of STOCKS & COMMODITIES, Volume 13: March.

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S&C - A Time Price Oscillator (Aroon).pdf

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