Detrended Price Oscillator: Works, Calculations, Advantages, and Conclusion

What is a Detrended Price Oscillator

The Detrended Price Oscillator (DPO) is a technical analysis tool used by traders to eliminate the long-term trends from prices, allowing a clearer view of the cyclical patterns and short-term trends. By removing the influence of long term trends, the DPO helps traders identify the highs & lows within the specific timeframe, making it easier to spot potential buy and sell signals. The detrended price oscillator strategy involves using the DPO Detrended Price Oscillator to identify overbought and oversold conditions for better timing of entry and exit points in short-term trading.

How the Detrended Price Oscillator Works

The primary function of the Detrended Price Oscillator is to remove the trend component from the price, effectively isolating the cyclical movements. This is achieved by comparing the price to the moving average that has been shifted back in time. The formula for the Detrended Price Oscillator DPO is:

Where:
  • Price is the current price of the asset.
  • SMA is the Simple Moving Average.
  • N is the chosen period for the moving average.

Calculating the DPO

1. Select a Time Period (N): Choose the number of periods over which you want to analyze the price movements.

2. Calculate the Simple Moving Average (SMA): Compute the SMA over this period.

3. Shift the SMA Back: Shift the SMA back by N/2+1N/2+1 periods to align it with the price data.

4. Subtract the SMA from the Price: Subtract the shifted SMA from the current price to get the DPO value.

Advantages and Limitations


Advantages

• Simplicity: The DPO is relatively simple to calculate and understand.

• Cycle Identification: It effectively highlights cyclical patterns and short-term trends.

• Eliminates Long-Term Trends: By removing long-term trends, the DPO provides a clearer view of short-term price movements.


Limitations

• Lagging Indicator: Like most moving averages, the DPO is the lagging indicator and may not respond quickly to sudden market changes.

• Not for Trend Analysis: The DPO is not designed to provide insights into long-term trends, so it should not be used as the standalone indicator for trend analysis.