Often, when we talk about oscillating indicators, what comes to mind are the usual… stochastics oscillators and moving average convergence divergence (MACD). Both are great indicators, which are very useful tools in a trader’s arsenal.
As oscillating indicators, both could give a clue as to whether price is overbought or oversold. These indicators act like a rubber band. As the movement of price pulls the indicator away from the zero line, the more overbought or oversold price becomes. The farther the indicator is from the zero line, the higher the probability that price could reverse, just as a rubber band pulls things back to itself.
Both have their strengths and weaknesses. Stochastic oscillators tend to work best when assessing short term trends. It is so effective with short term trends, it could detect minor gyrations in price movements. Scalpers use this to cash in on those slight movements.
MACD on the other hand, excels in detecting longer-term trends. If you’d look at MACD’s histograms, they tend be smoother. This is because MACD is less reactive to minute price movements. However, because of this MACD tends to be more of a lagging indicator.
So, we have an indicator for shorter-term trends with the stochastic oscillator, and we also have an indicator for the longer-term trends, the MACD. But what about the mid-term trend? What do we use if we prefer something that is not as lagging as the MACD and not as short-term as the stochastic oscillator?
The Detrended Price Oscillator (DPO)
The detrended price oscillator (DPO) is less popular compared to its peers, the stochastic oscillator and MACD. However, DPO offers a benefit that the other two don’t offer. DPO is the oscillator that excels in determining intermediate-term trends. Its sensitivity to price movements is somewhere in between the stochastic indicator and the MACD.
How does DPO work? Since it is still using moving averages, it is still somehow related to the MACD. However, since it is using displaced moving averages, it tends to lessen the effect of the most recent price action thus providing the trader a somewhat more intermediate type of trend.
One advantage of the DPO as compared to the MACD is that, unlike MACD which has smoother oscillations, DPO has more of a jagged and more recurring gyrations. These jagged oscillations tend to form sharper valleys and peaks, which could be connected making trendlines.
Entries Using the DPO Trendline Breakout
The DPO could be used to detect possible some shift in price. This is done by looking for breakouts occurring on DPO trendlines.
For a long (buy) trade, the following rules apply:
The DPO should be below the zero-line indicating the price is at the oversold territory. The farther away DPO is below the zero line, the more it is considered as oversold.
A trendline is drawn using the peaks of the DPO indicator, creating a resistance line.
As soon as the trendline is broken on the DPO indicator, the trade is entered as soon as the next candle opens.
For short (sell) trades, the following rules apply:
The DPO indicator should be well within the overbought territory. The farther above it is from the zero-line, the higher the probability that price would reverse.
A trendline is drawn using the valleys of the DPO indicator, creating a support line.
As soon as the DPO indicator breaks below the support trendline, the trade is entered on the next candle.
The Stop Loss
As for the stop-loss, it should be just a few pips below the signal candle for a long trade or a few pips above the signal candle for a short trade.
Take Profit Using DPO Indicator
We would again be using the DPO indicator to determine if we should already exit the trade.
For long (buy) trades, the following exit rules will be used:
The DPO indicator has already crossed-over from the oversold area to the overbought area above the zero line.
If price is already in the overbought area, as soon as the DPO indicator shows a slight downward slope, we could already exit the trade.
For short (sell) trades, the following rules would apply:
The DPO indicator is done crossing-over from the overbought to the oversold area below the zero line.
As soon as price is already on the oversold area, we will be closing our position as soon as the DPO indicator shows an upward slope.
The DPO indicator is an indicator that allows traders to look at trend from a different perspective. If you are the type of trader who would like to cash-in on those slight intermediate fluctuations of price, this strategy may work for you.
However, the DPO indicator used as a standalone indicator does have its own flaws. For one, since its movement is less smooth as compared to the MACD, being shaken off the trade will be common. As the DPO crosses over from oversold to overbought and vice versa, minor peaks and valleys could and would form on the DPO line. This causes the DPO line to have a slight slope going the opposite direction against the trade entered. But often these are only minor. However, the rules states that we should exit the trade on the slight hint of reversal. This causes the trader to be shaken off the trade and not be able to cash-in on the whole move. To get around this, it would be good to combine this strategy with another indicator used as an exit rule. It could be MACD or whatever suits best.
Still, even with these minor setbacks, if traded with a good money management strategy, this could still have an edge against the market. If as a trader, your objective is to make money on those intermediate price breakouts, learning about DPO might be a good idea.
How to install Detrended Price Oscillator Breakout Forex Strategy?