What is the Detrended Price Oscillator (DPO)
A detrended price oscillator is an oscillator that strips out price trends in an effort to estimate the length of price cycles from peak to peak, or trough to trough. Unlike other oscillators, such as the stochastic or moving average convergence divergence (MACD), detrended price is not a momentum indicator. It highlights peaks and troughs in price, which are used to estimate entry and exit points in line with the historical cycle.
BREAKING DOWN Detrended Price Oscillator (DPO)
A detrended price oscillator is one of many oscillators that can be used in technical analysis. In general, oscillators use trendlines that can be drawn either vertically or horizontally to help an investor identify signals.
Oscillators use trend lines to create bands for identifying technical analysis signals. Trendlines can be drawn at resistance and support lines creating a standard channel pattern for identifying resistance and support signals. Oscillator bands can also be drawn with vertical lines creating multiple trendlines that capture peak and trough movements.
Oscillators will typically use a scaling system from 0 to 100 which makes their construction slightly different than the development of standard envelope channels. Some of the most common oscillators followed by technical analysts include the stochastic, RSI, ROC, MFI and MACD oscillators.
Detrended Price Oscillator Calculation
The detrended price oscillator seeks to help a trader identify a security’s price cycle. Its charting strategy focuses more on price cycles than standard trends. To do this it utilizes several trendlines including vertical bands, simple moving average trendlines and a detrended price oscillator line.
These trendlines are calculated and utilized from the variables shown below:
X is first determined by the number of periods; 20 day or 30 day periods are common.
Simple moving average over an "n" day period is needed.
DPO = Closing price - Simple moving average [from (n / 2 + 1) days ago]
The cycles are created because the indicator is displaced back in time by (n / 2 + 1). The chart below shows how the indicator can help to identify historical peaks and troughs. The historical peaks and troughs in the indicator provide approximate windows of time when it is favorable to look for entries and exits, based on other indicators or strategies.
In the example below, stock in Armonk, N.Y.-based International Business Machines (NYSE:IBM) is bottoming approximately every 1.5 to 2.0 months. Upon noticing the cycle, look for buy signals that align with this timeframe. Peaks in price are occurring every 1.0 to 1.5 months - look for sell/shorting signals that align with this cycle.
The chart below also provides further insight on how different variables are factored into the DPO.