After news broke that Lehman Brothers (NYSE:LEH) was filing for bankruptcy, the market took a stunning drop reminiscent of that in 1987. Not only was there an upset with Lehman Brothers, but Bank of America Corporation (NYSE:BAC) bought Merrill Lynch (NYSE:MER), causing another surprising turn of events. Now with all eyes focused on the sudden underlying market changes, traders can turn to a bearish Aroon indicator for help.
Interpretation and Use
Within the Aroon indicator, there are two lines that vary between 0 and 100. These are aptly named "Aroon Up" and "Aroon Down". The strongest downtrends will always have the Down indicator hover near the 100 point mark, while the weakest downtrends will keep this value close to a lower point (around 30). It is a useful tool to investors and traders when they need to determine if a trend will remain intact.
If you are planning to short a stock, check that the Down Aroon is crossing up through the Up Aroon, and begins moving above 70; this short sell indicator is especially useful when the market itself is in a downtrend. When scanning, look for the lines to cross in order to catch a trend change. Keep in mind that when following a bullish or bearish Aroon indicator, a trader may receive false signals. In this case, other indicators could be added to the scan to determine the cross strength.
While each trader must separately set preferences like market, price range, volume, etc., here is the scan we used to find the list of today's short candidates:[Today's Aroon UP (25) > today's Aroon DOWN (25) and 2 days ago Aroon UP (25) < 2 days ago Aroon Down (25)].
|Company||Market Cap||Aroon Down Value|
|Devon Energy Corporation(NYSE:DVN)||41.7B||100|
|Beacon Power Corporation
Taking a look at the daily chart of Anadarko Petroleum, you'll see that it is trading below its 50-day moving average, which will likely be used by the bears as confirmation of an overall downtrend. It is important to note that is strong support near $53 (shown as the black horizontal trendline). At this point, there is a chance that the stock may find some ground and turn around; however, if the Down Aroon continues to trade above 70, it will be used to trigger another wave of selling pressure.
|Figure 1. Chart for Anadarko Petroleum|
Devon Energy Corporation
The Aroon scan that we used caught the UP Aroon crossing down through the DOWN Aroon last week on the chart of the Devon Energy. At this time it was not quite a short, waiting and allowing the UP Aroon to drop to 50 is prudent before entering a trade. The DVN short is attractive below 89.00 as there is some support at this level (shown by the black horizontal trendline). The short trade was also supported by the recent decrease in oil prices. Many will expect traders to hold a bearish outlook on this stock until the Aroon indicators cross back up and the price solidly trades above the 50 day moving average (blue line).
|Figure 2. Chart for Devon Energy|
Active traders can change the interval to 10 and look at the chart over 10 days for a different view, as shorter intervals are better suited to quick movements. Be sure that stocks are trading below their 50-day moving average before applying the Aroon to short. Look at any underlying commodity pricing if you are going to short a particular sector like oil or precious metals.
Wrapping It Up
Simplistic by design, the Aroon indicator is best suited for those traders and investors who not only want to determine that a trend is still intact, but want to establish if a trend will continue based news regarding recent global occurrences. As mentioned before, awareness is the key when following a bullish or bearish Aroon indicator. Always use stop losses to protect your capital in uncertain times.
For further reading, see Finding The Trend With Aroon