The Detrended Price Oscillator (DPO), as the name indicates, is a technical analysis tool designed to give information about the price of an asset without taking into account existing price trends. The logic behind this is that detrended prices can help traders to understand the buying and selling pressure in a market based on short-term fluctuations in the price of an asset, without taking into account larger upswings or downswings in price.
The Detrended Price Oscillator can be calculated by declaring a period of time that could be said to indicate a trend in price (for example, if prices steadily increase over a twenty-day period, then one could take “20” as the period of time that indicates a trend.) Divide this period by two and add one to arrive at a number n. Then take the moving average of an asset’s price n days before the period in question, and subtract this from the asset’s closing price for that period. The resulting number is the period’s DPO. This calculation method ensures that although short-term price trends are included in a DPO chart, longer-term trends are excluded.
One of the fundamental assumptions of the DPO is that long-term price trends are composed of short-term price trends, and that only by looking at short-term trends can long-term trends be understood. By this rationale, particularly severe peaks and troughs in the DPO indicate probable reversals in the overall trend of the asset price, and traders should take appropriate positions to take advantage of these reversals in either direction.