Oscillator Indicator: Detrended Price Oscillator (DPO)
Detrended Price Oscillator (DPO) is a lagging oscillation cycle indicator, developed to identify a cycle shift in equity by eliminating the overall trend of price action (PA), so called Detrended Price Oscillator.
The DPO identifies the underlying price action cycle (PA) by comparing the past price with simple average movements (SMA). The result is an oscillator that moves above and below the zero line as prices move above and below the SMA. This makes it easier to identify the length of the cycle, as well as the overbought or oversold conditions.
In essence, the DPO calculates the difference between the base price of the equity and the simple moving average of the price. Thus, the DPO is calculated in three stages:
First, calculate the simple moving average (SMA), ie (Total price for n period) / n; where n is the period for the DPO.
Now shift the SMA back half of the n period plus one period using the formula: (n / 2) + 1.
Lastly, subtract the price from the shifted SMA. Formulated form:
SMA: DPO = Price – SMA ((n / 2) + 1) past period
For better performance, the period for DPO, n, should be adjusted to fit the complete cycle length.
It is important to note that unlike most other oscilators, the DPO is basically a lagging / lagging indicator that can be projected forward.
In other words, the actual cycle of the DPO plot has correlation with the price (n / 2) + 1 period ago and not at the current price. Once the cycle length is identified, it can be projected forward to indicate the possible level at which price action (PA) can be expected to reverse direction. Thus, the length of the cycle, which can be identified by the high and low rhythmic repetitions tracked by the DPO, is essential.
DPOs are best used as an early warning system for possible trend reversals, but must be used with other indicators, which will act to confirm the warning.