Detrended Price Oscillator Indicator – Trading Strategy and Tips

The Detrended Price Oscillator indicator is a trading tool that clears out the vagaries of long-term price action to focus more on the underlying short-term price trends that make up the overall market. It displays as an oscillator that runs across a zero line, with either side indicating overbought and oversold levels.

This article treats everything you should know about the Detrended Price Oscillator indicator and how to apply it to your trading strategies. We also point out the benefits and the limitations associated with the indicator. Now let’s get right into it.

What is the Detrended Price Oscillator Indicator?

The Detrended Price Oscillator (DPO) indicator is a financial analysis tool used for identifying and analyzing underlying short-term cycles within price movements. It was developed by William Blau in 1991 and effectively filtered out long-term trends in the market, enabling users to focus on short-term price cycles and possible trend reversals.

Unlike other indicators that compare current and past prices, the Detrended Price Oscillator indicator compares a past price with its corresponding moving average. It works on the same principle as other price oscillator indicators, such as the Percentage Price Oscillator (PPO) and the Absolute Price Oscillator.

In a way, the detrended price oscillator attempts to filter out the market’s trend and focus on the underlying price movement cycles. The differences between the past asset’s price data and its corresponding SMA are then plotted as an oscillator that moves up and down a zero line, indicating bearish and bullish price action in the market.

Crucially, the Detrended Price Oscillator is not a momentum indicator. Instead, its primary use is to help traders identify high and low prices within price cycles and the cycle length. In other words, the Detrended Price Oscillator seeks to help traders identify cycles by comparing an asset’s price SMA to a historical price over a predefined period of time.

How Does the Detrended Price Oscillator Indicator Work?

By evaluating the differences between the past price data at a particular point and its corresponding Simple Moving Average (SMA), the indicator generates values that can either be more or less than zero, depending on the relative position of the SMA to price. The line of the indicator oscillates above and below the zero level.

In calculating the DPO value, the first thing is to consider the time in the past that you intend to look back and determine how many periods it is from the present. For instance, on a daily time frame, we could decide that our lookback period is 30 days from now. After that, we divide the lookback period (30) by two and add one period. This is 15 + 1 = 16. We can now confirm the closing price for the 16th period and subtract the SMA value of the 30th period from it.

In summary, the formula for generating the Detrended Price Oscillator is as follows.

Where X = Number of periods used for the past price

SMA= Simple Moving Average

When the detrended price oscillator crosses above the zero line, it implies a bullish turn, and you may decide to go long after confirmation with other tools and indicators. A cross below the indicator’s zero line also suggests a bearish run, which is good for a short-position trade entry.

In addition, the length of the period considered affects the sensitivity of the indicator. A shorter period makes the indicator’s lines fluctuate sharply relative to price action, while a longer period makes it less sensitive to price movement.

How to Use The Detrended Price Oscillator Indicator in Trading

The fundamental way to apply the Detrended Price Oscillator indicator to your trading strategy is to watch out for when it crosses the zero level. This typically allows you to identify the strength of a trend and can help you join an existing trend or identify price trends.

However, when the indicator reaches extreme levels, it could also signify that price action is in an overbought or oversold region. Usually, the levels that would count for your overbought or oversold thresholds would depend on your timeframe.

To use the DPO indicator, pull up the Detrended Price Oscillator indicator on your chart, immediately displaying below the price chart. Use the zero line as a reference point for a cross to indicate a shift in market momentum. A cross above this line shows that the market is bullish, and a cross below the line signifies a bearish trend. You can place a buy trade entry after it crosses above the zero line and confirm with another indicator or a simple moving average. When it crosses below the zero line, place a sell trade entry after confirming with another tool.

Alternatively, consider when the indicator reaches the overbought and oversold levels and determine when to enter a trade. When the price reaches an overbought level, there is an increased likelihood of a price reversal into a downtrend. The DPO helps you get a hold of this before the trend reversal. After confirming with other tools, enter a short position. The same applies to the oversold levels where a buying opportunity opens up.

Detrended Price Oscillator Indicator Trading Strategy Tutorial

Now, let us consider a step-by-step procedure for trading financial assets with the DPO indicator. In these examples, we look at two main trading strategies for the DPO indicator. The first strategy considers what actions to take when the indicator crosses the zero line. In the second strategy, we discuss how to trade the indicator when it reaches a certain level and confirm the sentiment with a moving average. Now let us get into it.

DPO Indicator Zero Line Crossover

Consider the following few steps to use the zero line crossover strategy for the Detrended Price Oscillator indicator.

1. Launch the DPO indicator below the main price chart.

2. Wait for the indicator to cross the zero line from one side to the other.

3. Enter an appropriate position after confirming those two steps. Place a buy position at the close of the bullish candlestick and a sell position at the close of a bearish candlestick.

4. Place your stop loss just below the entry candlestick for a buy trade or just above for a sell trade.

5. Place your first take profit using the 1:2 risk-reward ratio. As another take-profit tool, you can use the crossover of the indicator in the opposite direction.

DPO Indicator with Moving Average

Another strategy using the DPO indicator is to integrate a moving average indicator as an extra confluence trading tool. The idea behind this strategy is to get a buy or sell signal from the DPO indicator and then confirm this with a moving average. So, let us look at how to deploy this strategy in the following few steps.

1. Launch your DPO indicator below the price chart and a 14-period SMA on the price chart.

2. Take long positions when the price outshoots the SMA to the upside and the DPO crosses the zero line to the upside. It doesn’t matter what comes first. And conversely, your short trade entry comes when the price falls below the SMA, and the DPO crosses its zero line to the downside. 

3. Set your stop loss below the nearest swing low for a bullish trade and above the closest swing high for a bearish trade. Take profit when price action breaks out of the SMA in the opposite direction.

Detrended Price Oscillator Indicator – Pros and Cons

The Detrended Price Oscillator indicator is helpful for getting into an existing trend and identifying new ones. Furthermore, combining it with other indicators significantly improves its effectiveness. However, it is mired with some limitations that stall its effectiveness as a stand-alone indicator. We discuss some benefits and limitations of the Detrended Price Oscillator indicator below.

Benefits of Using the Detrended Price Oscillator Indicator

The Detrended Price Oscillator indicator helps to identify existing and new trends and make good use to find trading opportunities. When fine-tuned by other relevant tools, these opportunities are significant for your profit margin.

Additionally, unlike other indicators that do not work well in the sideways market, the DPO can be extremely effective in this market scenario, and therefore, it can be integrated into the range trading strategy or the breakout trading strategy. 

Some benefits of the Detrended Price Oscillator indicator are listed below.

Limitations of the Detrended Price Oscillator Indicator

The Detrended Price Oscillator should not be considered alone for trading signals, just like other indicators. This is because its limitations sometimes reduce its effectiveness as a stand-alone indicator.

As mentioned, the DPO is not a momentum indicator, which means it cannot be used as a reliable indicator for generating trading signals. Instead, it is used as a destination of the asset’s price cycle with a mark of the closing price relative to the high and low prices over a period of time.

Key Takeaways

Frequently Asked Questions About Trading the DPO Indicator

The following are some of the most frequently asked questions about the Detrended Price Oscillator Indicator.

What is a DPO trend?

The DPO trend refers to the short-term price movement pattern the indicator generates. By focusing on the cyclic nature of price movements and removing long-term trends, the indicator helps to identify trend reversals for making informed decisions. The DPO trends are characterized by a crossover above or below the zero line, signifying a shift into bullish or bearish runs in the market.

What are the best settings for the Detrended Price Oscillator indicator?

The best settings for the DPO indicator depend mainly on user preferences. Many traders use period values between the range of 10- 30. Generally, a shorter period makes the indicator respond more sharply to price movement. Whereas a longer period smoothes out the line of the indicator, capturing a broader trend.

Is the DPO indicator available on Metatrader 4/5?

Yes, the DPO indicator is available on MT4 and MT5 platforms. By clicking the indicators tab and searching for the DPO, you can launch the indicator onto your chart to analyze price cycles and potential trend reversals.