Brian BollenThe Detrended Price Oscillator (DPO) is used to remove trend from price. This is done in order to identify and isolate short-term cycles. The DPO indicator is not typically aligned with the most current prices. It is offset to the left (the past) which helps to remove current trend.
Because it is offset to the past, the DPO is not considered a momentum oscillator. It only measures past prices against a simple moving average as a way to gauge a cycle’s high/low range as well as typical duration, says Bramesh Bhandari, an Indian stock market trader and regular contributor to investment trade publications.
Long-term cycles are made up of a series of short-term cycles. Analysing these shorter-term components of the long-term cycles can be helpful in identifying major turning points in the longer term cycle. The DPO helps investors/traders remove these longer-term cycles from prices.
DPO calculation
To calculate the DPO, it is necessary to specify a time period. Cycles longer than this time period are removed from prices, leaving the shorter-term cycles.
First create an n-period simple moving average (where “n” is the number of periods in the moving average).
N refers to the number of periods used to calculate the DPO. A 20-day DPO would use a 20-day simple moving average (SMA) that is displaced by 11 periods {20/2 + 1 = 11}. This displacement shifts the 20-day SMA 11 days to the left, which actually puts it in the middle of the look-back period.
The value of the 20-day SMA is then subtracted from the price in the middle of this look-back period. In short, DPO(20) equals the price 11 days ago less the 20-day SMA. The DPO is most effective with indicator periods of 21 days or less, Bhandari explains.
The real power of the DPO is in identifying turning points in longer cycles. When DPO shows a higher trough – expect an upturn in the intermediate cycle. When DPO experiences a lower peak – expect a downturn in the intermediate cycle.
Identifying turning points in a stock cycle
Stock cycles are created because the indicator is displaced back in time. The historical peaks and troughs in the DPO provide approximate windows of time when it is favourable to look for entries and exits, based on other indicators or strategies.
The DPO shows the difference between a past price and a simple moving average. In contrast to other price oscillators, DPO is not a momentum indicator. Instead, it is simply designed to identify cycles with its peaks and troughs.
Cycles can be estimated by counting the periods between peaks or troughs. Users can experiment with shorter and longer DPO settings to find the best fit. For further information, tuition and advice, try Bramesh’s own website.
Words of warning
As with everything relating to investing/trading, it is necessary to add a caveat or two after this blizzard of information. Not least because not everyone is convinced about the actual value of the DPO.
For instance, specialist hedging firm JCRA said: “One of the team here stressed that it is largely agreed that the ‘techniques’ don’t work and someone trying to make money this way will probably be seen as naïve.”
In conclusion
Trading based on a single indicator is dangerous and anyone participating in the market should always use such indicators in conjunction with others.
Setting up several at a time should help demonstrate if they each confirm the other's suggested direction of movement. Trading can be dangerous. Do not commit more money to trading than you can comfortably afford to lose outright.