A trader's guide to the detrended price oscillator
The detrended price oscillator (DPO) helps traders identify overbought and oversold markets. Here, we explain the DPO and some of the trading strategies associated with it.
What is the detrended price oscillator (DPO)?
The detrended price oscillator (DPO) is an indicator that attempts to filter out short-term price trends to highlight the broader, underlying cycles of price movement. It uses a zero line in the centre, either side of which price trends are plotted according to a comparison of overbought and oversold areas.
The detrended price oscillator is lagging by nature; it is based on waiting for a movement to occur before opening a position. DPO is calculated as the difference between the past price of an asset (at a specific time) relative to its simple moving average (SMA). Any figure higher than the SMA suggests that the DPO is in overbought territory, and vice versa.
Overbought areas are highlighted in green above the zero line and oversold areas are shown in red below the zero line. The below price graph has an example of the detrended price oscillator indicator and how it maps price movement above and below the zero line.
If the detrended price oscillator is above the zero line, it can be interpreted as a bullish sign, because the price is above its normal moving average. Some traders choose to go long as soon as the DPO moves above the zero line. The opposite is also true – when the oscillator moves below the zero line, traders interpret it as a bearish sign and often choose to go short.
Remember that the detrended price oscillator should not be used in isolation when trying to confirm a signal. You should take the necessary steps to manage your risk, such as adding stops and limits, and do thorough technical analysis of the market you’re trading.
Detrended price oscillator formula
The detrended price oscillator formula is:
So, to calculate the DPO, first determine what your lookback period will be. If you are looking at a weekly chart, use weekly periods – for example 28 weeks. Then, find the closing price using the formula. Using the example of 28 weeks, you will need to take the closing price from 15 weeks ago ([28 weeks/2] + 1 week ago), then subtract the simple moving average for the last 28 weeks.
When using IG’s trading platform, you do not need to plot the DPO yourself, as this can be done by the click of a button. Try the platform by signing up for a demo account.
How to trade using the detrended price oscillator
Follow these steps to trade using the detrended price oscillator:
- Create an IG account or log in to your existing account
- Enter the asset you want to trade in the search bar
- Right click on the chart and select ‘Detrended price oscillator’ under ‘Indicators’
- Select ‘buy’ or ‘sell’ in the deal ticket
- Enter your position size and add stops and limits
- Confirm the trade
If you’re new to trading, you need to understand the basics of financial markets and indicators before trading the DPO. You can start by visiting IG Academy for free online trading modules.
Detrended price oscillator trading strategies
Some detrended price oscillator strategies include:
DPO crossover and candlestick patterns
Combining the crossover of the detrended price oscillator over the zero line with candlestick patterns is one way to confirm a buy or sell signal. A buy signal comes when the oscillator crosses above the signal line, while a sell signal comes when the oscillator crosses below the signal line. The crossover signal should be supported by the candlestick pattern moving in the same direction.
For example, if the DPO moves above the zero line and the candlestick pattern is also suggestive of a bullish trend, the signal may be confirmed. The same will apply for bearish crossovers and price action.
If price action breaks the trend or the detrended price oscillator crosses the zero line in the opposite direction, you may want to close the trade.
DPO and volume
Because volume indicators show the degree of market activity, they can help you to identify price trends that correlate with the DPO signal. The strategy is to place trades based on the DPO during high or increasing volumes and avoid price oscillator signals during low trade volumes.
It is not recommended to build a trading strategy on the detrended price oscillator alone. Rather test signals against other indicators and use stops and limits when you trade.
Detrended price oscillator summed up
- The DPO attempts to highlight broader, underlying cycles of price movement
- If the DPO is above the zero line, it can be interpreted as a bullish sign, and some traders choose to go long
- If the DPO is below the zero line, it can be interpreted as a bearish sign, and some traders choose to go short
- Some of the most popular trading strategies involving the DPO are crossovers and volume trading
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