Commodity Channel Index – Understanding the basics

Commodity Channel Index, or CCI for short is an indicator in technical analysis, used in identifying the cyclic trends in security and is commonly used to analyze commodities. It measures the currency price relative to an average price level for a given time period. Donald Lambert developed the Commodity channel index and is used as a versatile indicator to identify new trends or warn the trade of volatile trading conditions. The Commodity Channel indicator can be used not only for commodity trading but can be equally used with trading ETF’s, Indices, stocks and forex markets.

The way the CCI works is quite simple. The CCI reading is relatively high when prices are far above their average and is low when prices fall below their average. Thus, CCI can be efficiently used for identifying any overbought or sold levels and hence applied to commodities trading. CCI is popularly used amongst technical investors and is used to determine the trends in just about any trading asset including equities and currencies as well.

The CCI can be a valuable tool to identify potential highs and lows in an asset’s price when used in conjunction with other oscillators. The Commodity channel index thus provide traders with enough insights to help them estimate the changes in the direction of price movements for the asset of their interest.

About Commodity Channel Index

The Commodity Channel Index (CCI) is flexible enough to be used as either a coincident indicator where surges above +100 displays strong price action that signals the start of an upward moving trend or a leading indicator where plunges below -100 reflect upon a weak price action that signals the start of a downward trend.

Commodity Channel Index - Oscillator
Commodity Channel Index – Oscillator

The CCI indicator is made up of a single fluctuating curve where in, the signals foretell that a change in trend (or price correction) is around the corner. The CCI technical indicator is designed to hover between the boundary limits 70% to 80% of the time which results in trading alerts 20% to 30% as well. The only weakness in using the Commodity Channel Index is that the cycles are often difficult to determine in the forex market.

The Commodity Channel Index Formula

(Closing Price – Moving Average of the security)/(0.015 x Mean deviation of the moving average)

The default period for the CCI indicator is 14 periods similar to the slow stochiastics and RSI. The time period plays a key role in the accuracy of the CCI. The default period can be adjusted which increased or decreases proportionately the number of signals the sensitivity. The most commonly used time interval setting for CCI is 20.

Calculating the time intervals for CCI

Calculating the time periods for the Commodity Channel Index can be done as follow. Open a security’s yearly chart (for example: Gold, for the period of 2010). Then locate two highs and lows on the chart and take note of the time interval between them. Divide the time interval by three to get the 1/3rd of the cycle to be used in the calculation. Based on this example, the average trading days is about 225, which when divided by three gives a time period of 75.

Understanding Buy/Sell Signals using the CCI

Potential sell signals: When the CCI crosses above 100 and starts to slope downwards which is indicated by a bearish divergence between the actual movement of the price and the CCI, it is represented by a downward shift in the CCI as the price of the asset continues to shift upwards or moves sideways.

Potential buy signals: When the CCI crosses below -100 and has started to curve upwards which is indicated by a bullish divergence between the actual movement of the price and the CCI, it is represented by an upward shift in the CCI as the price of the asset continues to shift downwards or sideways.

Divergence Trading is another way to trade with the CCI. Because of its oscillating nature, a divergence between price action and the CCI can visually represent a change in price direction. Click here to learn more about divergence trading.

About the author: Editorial Team


Related Posts