How to use the Detrended Price Oscillator in trading

How to use the Detrended Price Oscillator in trading

The Detrended Price Oscillator (DPO) is a relatively uncomplicated tool of analysis that can be used to simplify a chart and identify conditions ripe for buying or selling. It turns the moving average line of a price chart into a flat horizontal axis, with prices plotted according to their distance from the moving average.

Moving averages are important components of many technical indicators. A simple moving average determines the average of a range of closing prices for a security or index for a specific period of time. An exponential moving average is a moving average that gives more weight to the most recent data. Simple moving averages are not weighted for time the way that exponential moving averages are, which has the effect of snapping the chart to the most current information, while simple moving averages have lag.

The DPO is said to detrend the information in a regular price chart by completely smoothing out the trends that would otherwise be visible in price movements and their moving average line. It further distances the oscillator from the noise of recent price moves that might misguide an analyst looking for trends. Essentially, the DPO puts blinders on for traders by only comparing the current closing price to the value of the moving average line from numerous days in the past (n/2 +1, where n is the length of the SMA line’s look-back period).

By establishing the difference in the current closing price to the SMA value from several days ago, the current values of stocks are compared to intermediate-level trends rather than shorter-term movements and momentum.

When the Detrended Price Oscillator is hovering below the zero line or moving sideways below the zero line, it could be a sign that the security is oversold. This could present the trader a buying opportunity to go long the security or perhaps explore call options. The opposite also holds true -- when the Detrended Price Oscillator is above the zero line it could signal the security is overbought and the price is too high, signaling to traders they may want to consider selling or hedging with put options.

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The DPO is more of a confirmation tool than a trade signal – it gives analysts another way to take emotion and intuition out of their decision-making process. It can be especially useful when evaluating a position that is intended to be held for a moderate amount of time. A similar tool is Andrew’s Pitchfork, which defines trends with support and resistance lines around a median line, all three of which are derived from three points at peaks and troughs around the onset of a current trend. The overlay takes the shape of a trident or pitchfork, with Andrews calling the lines “tines,” after a pitchfork’s prongs.

Technical analysis is more popular than ever, but it’s important to remember that there is no single indicator that works well for all securities. Technology allows us to not only see and share trading information more quickly than ever before, but to automate trades using a disciplined technical strategy we define. Artificial intelligence tools from Tickeron can aid traders with trade ideas, help analyze signals to execute advantageous trades, and assist investors with making rational, emotionless, and effective trading decisions.

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