What is a trendless price oscillator (DPO)?
A trendless price oscillator, used in technical analysis, removes price trends in an effort to estimate the length of peak-to-peak or valley-to-valley price cycles.
Unlike other oscillators, such as Stochastic or Moving Average Convergence Divergence (MACD), the DPO is not an indicator of momentum. Instead, it highlights the peaks and troughs in price, which are used to estimate buying and selling points in line with the historical cycle.
- The trendless price oscillator (DPO) is used to measure the distance between peaks and troughs in the price / indicator.
- If the depressions have historically been two months apart, that can help a trader make future decisions as they can locate the most recent depressions and determine that the next one may occur in about two months.
- Traders can use estimated future peaks as selling opportunities or estimated future troughs as buying opportunities.
- The indicator is generally set to look back for 20 to 30 periods.
The formula for the trendless price oscillator (DPO) is:
DPOR=PrICme FrORsubway 2X+1 PmerIORDs togramOR–X PmerIORD SSUBWAYTOwhere:X = Number of periods used for the lookback periodSMA = Simple Moving Average
How to calculate the trendless price oscillator (DPO)
- Determine a lookback period, such as 20 periods.
- Find the closing price x / 2 +1 periods ago. If you use 20 periods, this is the price from 11 periods ago.
- Calculate the SMA of the last x periods. In this case, 20.
- Subtract the SMA value (step 3) from the closing price x / 2 +1 periods (step 2) to get the DPO value.
What does the trendless price oscillator tell you?
The trendless price oscillator seeks to help the trader identify the price cycle of an asset. It does this by comparing an SMA with a historical price that is close to the middle of the look-back period.
When looking at the historical peaks and valleys in the indicator, which line up with the peaks and valleys in price, traders will typically draw vertical lines at these junctures and then count the time between them.
If the funds are two months apart, that helps to assess when the next buying opportunity may come. This is done by isolating the most recent low in the indicator / price and then projecting the next two lower months from there.
If the peaks are generally 1.5 months apart, a trader could find the most recent peak and then project that the next peak will occur 1.5 months later. This projected peak / time frame can be used as an opportunity to potentially sell a position before the price falls back.
To further help with trade timing, the distance between a trough and a peak could be used to estimate the duration of a long trade, or the distance between a peak and a trough to estimate the duration of a short trade.
When the price of x / 2 + 1 periods ago is above the SMA, the indicator is positive. When the price of x / 2 + 1 periods ago is below the SMA, then the indicator is negative.
The trendless price oscillator does not go until the last price. This is because the DPO is measuring the price x / 2 +1 periods relative to the SMA, so the indicator will only go up to the previous x / 2 + 1 periods. However, this is fine because the indicator is meant to highlight historical peaks and valleys.
The indicator varies and also moves to the past, so it is not a useful real-time indicator for the direction of the trend. By definition, the indicator is not used to assess trends. Therefore, determining which trades to perform is up to the merchant. During a general uptrend, the lows of the cycle are likely to present good buying opportunities and the peaks, good selling opportunities.
Example of how to use the trendless price oscillator
In the following example, International Business Machines (IBM) is bottoming out roughly every 1.5 to two months. When noticing the cycle, look for buy signals that align with this time frame. Price spikes occur each one and a half months; look for sell / short signals that line up with this cycle.
Difference between trendless price oscillator (DPO) and commodity channel index (CCI)
Both indicators attempt to capture cycles in price movements, although they do so in very different ways. The DPO is used primarily to estimate the time it takes for an asset to move from one peak to another or from one valley to another (or from one peak to another, or vice versa). The Commodity Channel Index (CCI) is generally capped between +100 and -100, but a breakout of those levels indicates that something major is happening, such as the start of a major new trend. Therefore, the CCI focuses more on when a main cycle could start or end, and not on the time between cycles.
Limitations of using the trendless price oscillator
The DPO does not provide trading signals on its own, rather it is an additional tool to assist at the time of trading. It does this by observing when the price has peaked and bottomed in the past. While this information may provide a baseline or baseline for future expectations, there is no guarantee that the length of the historical cycle will repeat in the future. Cycles could be lengthened or shortened in the future.
The indicator also does not take the trend into account. It is up to the trader to determine which direction to trade. If the price of an asset is in free fall, it may not be worth buying, even at the lows of the cycle, as the price could continue to fall soon anyway.
Not all the peaks and valleys of the DPO will move at the same level. Therefore, it is also important to watch the price to mark the important peaks and valleys in the indicator. Sometimes the indicator may not go down much or go up much, but the reversal from that level could still be significant for the price.