The detrended price oscillator (DPO) is a technical analysis indicator traders use to identify cycles and emerging trends in stock prices. It works by removing or ‘detrending’ the long-term price drift from the data to allow traders to spot shorter-term price oscillations.

The detrended price oscillator is valuable to traders as it can help pick up on shifts in sentiment and changes in the prevailing trend earlier than some other indicators. Learn everything you need to know about this indicator so you can maximize its potential and win the market effortlessly.

What does “Detrending” mean?

Detrending refers to removing the long-term price trend from time-series data. Over long periods, asset prices often move in a general direction, higher or lower, depending on economic growth, inflation, recession, etc. These very long-term price moves are known as the trend. However, prices do not usually move straight up or down but rather in a zig-zag pattern of shorter-term cycles and counter-cycles.

By removing the long-term trend, analysts can see the shorter-term cycles. Think of detrended data as showing the hills and valleys, while the trended data only indicates the overall slope of the landscape, whether tilting higher or lower.

What is the use of a detrended price oscillator?

The motivation behind detrending price data is to make it easier to identify cycles that signal shifts from bullish to bearish sentiment or vice versa. Shorter bullish and bearish cycles often play out over the top of major long-term trends. Knowing where you are in a cycle can help traders better time entries and exits when trading or investing.

For example, a stock may be in a long-term uptrend channel, but regular bullish and bearish cycles play out within a shorter timeframe. These shorter cycles present trading opportunities to buy pullbacks and take profits. The detrended price oscillator helps clarify cycle analysis to capitalize on the short-term swings.

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How to Interpret Divergences and Signals

Signal line crossovers

When a short-term moving average applied to the detrended price oscillator crosses the main DPO line, it generates trading signals. A 9-day moving average is commonly used as the signal line. Upward crossovers with the DPO suggest bullish sentiment, while downward crossovers suggest bearishness.

Centerline crossovers

The detrended price oscillator oscillating from positive to negative territory shows a change in the shorter-term cycles. An upward, centerline crossover is viewed as a bullish signal, while a downward crossover signals the start of bearish sentiment.

Divergences

One of the most critical signals from the DPO is divergence with the price action. Divergence signals when momentum is shifting before the price.

For example, when prices are trending higher, but the detrended price oscillator starts trending lower, it shows bearish divergence, signaling an upside cycle may be ending. The opposite bullish divergence can signal the start of an uptrend.

Bearish divergences form when prices make a higher swing high while the DPO forms a lower high, indicating waning buying strength. Bullish divergences form when prices drop to a lower swing low, but DPO holds above its prior low, signaling gathering bullish momentum.

Fine-Tuning DPO Indicator Settings 

The standard setting for creating the detrended price oscillator is a 26-day moving average. Shorter settings like 13 days will produce more frequent trading signals but likely more false signals or whipsaws.

Longer moving average periods, such as 50 days, will trigger fewer but likely higher probability signals aligned with the major bull/bear cycles. 

Traders often add a signal line, a 9-day moving average of the DPO, to generate crossover signals. The signal line smooths out oscillations on the DPO line for a more straightforward interpretation.

To confirm signals, the DPO can be combined with momentum oscillators like the Moving average convergence/divergence (MACD) and Relative Strength Index (RSI) for greater accuracy in spotting cycle turns. Volume and market breadth indicators also add additional perspective.

Strengths and Weaknesses of the Indicator

The detrended price oscillator possesses several strengths that enhance its utility in technical analysis. Firstly, it effectively eliminates long-term drift from prices, simplifying the identification of market cycles. The oscillator format provides clear signals, particularly when crossing above or below the centerline or signal line, offering traders easily interpretable indicators. Additionally, DPO facilitates straightforward sentiment analysis, with readings above zero signaling a bullish market and those below zero indicating bearish conditions. 

However, it is crucial to acknowledge the weaknesses inherent in DPO. Like many other trend-following indicators, DPO exhibits a lag, generating signals after a trend change has been initiated. Furthermore, it may produce false signals or whipsaws during minor cycle fluctuations. 

To overcome the limitations of relying solely on DPO, traders and analysts frequently employ additional technical analysis methods to confirm their findings and gain a more thorough understanding of market behavior. 

By utilizing various techniques, such as moving averages, trend lines, and candlestick patterns, they can better identify trends, support and resistance levels, and potential entry and exit points for trades. This comprehensive view of market dynamics can help traders make more informed decisions and improve their overall success rate.

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In Essence

The detrended price oscillator strips out long-term trends, allowing traders to spot bullish and bearish sentiment cycles. By oscillating above and below a centerline at zero, the DPO produces clear signals as it crosses into positive and negative territory.

Traders can also look for signal line crossovers and divergence with price to profit from short-term countertrend moves within more significant trends. The indicator isn’t perfect, so look for confirmation testing signals against historical price action and other indicators. 

Learning to fine-tune settings and use them with other indicators takes practice but is vital to maximizing its potential. Further, joining trading communities or reviewing additional resources can allow traders to discuss the profitable use of the DPO and learn from experienced traders. 

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“When considering “CFDs” for trading and price predictions, remember that trading CFDs involves a significant risk and could result in capital loss. Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be considered investment advice.