Detrended Price Oscillator

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Introduction

Oscillators are typically used by traders to analyse momentum of trends. By being able to identify if the current trend is increasing or decreasing, traders can increase their probability of success. The Detrended Price Oscillator (DPO) is an oscillator designed to remove the long term trend from price action to make it easier to identify cycles and overbought and sold conditions. The DPO is not a momentum based indicator which good at identify long term trends. It is more useful in identify cycle turning points and short term market conditions.

Calculation

  1. Calculate a simple moving average based on n-periods
  2. Adjust simple moving average by half the cycle period: (n / 2 +1)
  3. Subtract the adjusted moving average from close.

Detrended Price Oscillator (DPO) = Close – SMA [(n / 2 + 1)]

Where:

N= period of time

SMA= Simple Moving Average

Close= Closing Price

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Interpretation

The DPO formula is displaced moving averages that had been adjusted backward in time in order to forecast trends. Displacing simply means that the moving average is shifted back by a number of intervals. A positive calculation will lead the original SMA and a negative calculation will lag the original moving average. This adjustment results in a more “centred” moving average relative to the simple moving average.

The goal behind the DPO is to eliminate to any long-term trends. By leaving short-term trends traders identify immediate overbought and oversold levels more effectively.

Conclusion

The best quality of the DPO is that is different than most indicators. While most oscillators are in one shape or another purely momentum indicators, the Detrended Price Oscillator in that is not. The strength of the DPO indicator is in its ability to identify cycle peaks and troughs. By counting the periods between peaks or troughs the DPO can estimate cycle periods. Once traders are able to determine cycle period then they can anticipate potential turning points. As with all indicators, traders and investors can improve their success by incorporating multiple indicators to confirm key turning points or reversals. Most importantly, the overriding price action should be the ultimate arbiter and indicators should be additional tools to improve decision making process.