The Detrended Price Oscillator (DPO) is a technical analysis tool designed to remove the influence of the general trend from the price action and make it easier to identify cycles. The DPO falls in the category of momentum indicators, but is also different from MACD. The former is used to identify high and low points within the cycle as well as to estimate its length. Read the full article to learn how to apply it in trading!
What is the DPO?
As can be seen from the name of the indicator itself, the DPO is used to remove the influence of a long-term trend on the current prices. But why would a trader want to do that? Aren’t you supposed to follow the trend? Turns out, sometimes it is easier to estimate the longevity of a trend and forecast an upcoming reversal when trend-related price movements are completely removed from the graph.
What you get in the end is a curve that is quite similar in its shape to the actual price chart. The most noticeable difference between the two is the lack of a major trend on the DPO. In order to use the indicator correctly it is important to understand that the Detrended Price Oscillator is based on the use of a moving average, offset several periods to the left. The indicator will compare past prices with a moving average.
How to set up?
Setting up the Detrended Price Oscillator is easy. In order to do so:
- Click on the ‘Indicators’ button in the left-hand bottom corner of the screen and go to the ‘Momentum’ tab,
- Choose the ‘DPO’ from the list of available options,
- Without changing the default setting hit the ‘Apply’ button. Or you can adjust the period and the baseline (either to make the indicator more sensitive, or to decrease the number of false alarms).
The indicator is ready to use!
How to use in trading?
As mentioned earlier, the Detrended Price Oscillator measures the difference between the past price and the moving average. The horizontal line corresponds to the displaced moving average. The DPO, therefore, is positive when the price is above and negative when below the average .
The indicator is especially useful when trading on shorter time frames. Not being interested in long-term trading, you might want to exclude lasting trends from your estimates and only consider shorter fluctuations. For this purpose DPO can be a great tool. If it is your case, take a brief look at the DPO before opening the deal and you will know to what extent the prevailing trend is responsible for the price change.
DPO can also be used to estimate the average cycle length. For example, when trading CFDs on a particular stock, you might want to know the amount of time it takes for the price to appreciate and then decline. Financial markets have a tendency to repeat themselves. Periods of growth will, therefore, intermingle with periods of depression. Using DPO you can be prepared for an upcoming trend reversal. Calculate the distance between the neighboring highs and lows to estimate the average cycle length. Consider using it later when the ongoing cycle is about to end.
The indicator is best used as a supportive tool and can be paired with a trend following indicator (MA, Alligator), MACD or ATR. Note that as any other indicator it can provide false signals from time to time.
