The Detrended Price Oscillator (DPO) indicates when market trends may stop and can be used to determine cycle highs and lows along with estimate cycle times. The DPO does not apply to the last date because it is based on a moving average. The indicator can show intermediate overbought and oversold levels effectively. The term detrended is derived from the term detrend. It is the opposite of using a trending. Detrending is a concept that is used because some cycle behaviour is usually dependent on the direction of the next cycle. The reason for detrending is to remove the noise that is brought about by price movements.
What does the Detrended Price Oscillator measure?
The detrended price oscillator (DPO) measures the difference between the past price and the moving average. Note that the DPO itself is placed on the left. The indicator fluctuates above/below zero when prices move above/below the moving average. The chart below shows the USD/CAD pair with a change in the 20-day moving average of -11 days. A 20-day DPO will appear in the lower indicator window. Note how positive/negative the DPO is if the price is above the moving average and if the price is below the participating moving average.
Detrended Price Oscillator calculation
The price {X / 2 + 1} periods minus the simple moving average of period X.
X: number of periods used to calculate the lower oscillator.
The 20-day DPO uses a 20-day SMA, which is compensated by 11 periods {20/2 + 1 = 11}. This shifts the 20-day SMA 11 days to the left, putting it in the middle of the reviewed period. The 20-day SMA value is then deducted from the price in the middle of the release. In short, DPO (20) is the price that deducts the 20-day SMA before 11 days.
How to use the Detrended Price Oscillator?
Although the DPO indicator appears to be a classic oscillator but it is not for momentum signals. The simple moving average has been established in the past, so the DPO is presented in the past. Even at this offset, the DPO’s peaks and valleys can be used to estimate the length of the cycle. DPO filters out longer trends to focus in shorter cycles. The following daily chart of USD/CAD shows that the price marked the lows in early July, early August and early September while the October missed the pattern. There are about 20 days between these cycles. The cycle shows the second half of 2019.
If we simply observe the price and the indicator with the naked eye, it seems quite accurate in predicting the price. However, the indicator cannot clearly inform the traders whether the price has reached the top or bottom until the price starts moving in the counter direction.
For example, take a look at the following chart:
The recent price action does not clearly inform whether the trend will continue or reverse from here. That will only become obvious when the price starts moving to a certain direction.
If you look at the highlighted part of the chart above, it looks like DPO is showing a top and the value of DPO started falling as well but the price did not stop rising more.
However, this tool can be of great use for the long-term traders who like to add more positions on each weakness or strength and then hold the positions for a long period of time.
Apart from the inabilities and drawbacks of the DPO, the indicator helps to determine the top and bottom effectively. iIt can be used for trading forex, stocks, commodities, precious metals, indices, cryptocurrencies and more.
Detrended Price Oscillator trading strategy
You can combine other trend indicators with the Detrended Price Oscillator but here we will present a simple trading strategy that does not include any other indicators. We take the zero line as the decisive point to enter the trade. The same zero line can indicate the exit of a trade as well.
When the Detrended Price Oscillator is applied on a chart, it usually appears as a line that moves up and down. It usually ranges between -0.05 and +0.05.
Detrended Price Oscillator buy trade setup
- We may buy an asset if the value of DPO crosses above the zero line.
- We may place the stop-loss slightly below the recent swing low.
- We may exit when the DPO value crosses below the zero line.
Detrended Price Oscillator sell trade setup
- We may sell an asset if the value of DPO crosses below the zero line.
- We may place the stop-loss slightly above the recent swing high.
- We may exit when the DPO value crosses above the zero line.
Detrended Price Oscillator conclusion
The detrended price oscillator can be a useful trading indicator to incorporate within your trading strategies. However, there can be many false signals produced as with any other forex indicator.
The Detrended Price Oscillator attempts to remove trend from price in order to allow identification of cycles more easily. Cycles longer than the period specified for the indicator are removed, leaving only the shorter-term cycles. DPO is displaced to the left so that the indicator is aligned with the peaks and troughs in price.
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