How to make money in stock market by using the Detrended Price Oscillator

Detrended Price Oscillator (DPO) was developed to identify the cyclical change in equities by eliminating the overarching trend from the price action. This is done by comparing the past price by a displaced simple moving average (SMA). Herein, instead of concentrating on the broad outlook of a trend, intermediate peaks and trough, based on the past price action, provide significant triggers.

The indicator is plotted on the scale of zero line. Whenever the price moves above the SMA, the indicator will trade above or below the zero indicator. This assists in determining the change in trend. When the indicator is above the zero line, the stock price is said to sustain above the displaced SMA -- which indicates a bullish bias -- and vice versa.

The key significance of the DPO is to identify the price cycle. The idea is to capitalize on the short–term trend, based on the past performances. This helps traders understand earlier volatility and the time period of the trend.

How to analyse DPO

To identify the short-term trend, the traders can evaluate the peak and trough of the indicator with the price high and low, respectively, and count the number of periods to gauge the overall time scale. For instance, suppose the highs are 15 sessions apart from earlier scenario, then, as per the indicator, the next possible high may bear the same time period.

The DPO clearly facilitates in idealizing the time period of the price cycle. This helps traders and investors to have a better understanding of the time scale.

The DPO is highly accurate when the overall trend supports the price. However, identifying a trend solely based on DPO may not provide the anticipated outcome.

Let’s consider the daily chart of Cholamandalam Investment and Finance Company Ltd (CHOLAFIN). Here, the recent trend in the last 10 months has seen the counter bottoming out in 7-12 sessions. Now that the indicator is trading above the zero line, the price is expected to see upside in the coming sessions. As per the chart, the upside trend is optimistic for nearly 20-25 sessions.

So as per the DPO indicator, the price is expected to see positive direction with sentiment staying optimistic. This scenario helps to identify the change in price reversal and can determine the expected sustainability based on the earlier price cycle.

In a nutshell, this indicator serves to identify the time cycle based on the earlier short-term trend. It was not developed to identify the stocks or build strategies. Neither can it calculate the profits or returns. However, if used in combination with other technical indicators, the DPO indicator can provide high confirmation of the trend. And although it is a lagging indicator, the time cycle facilitates in taking an informed decision.