Commodity Channel Index (CCI)
What is a CCI?
The CCI is a short form for the Commodity Channel Index. This indicator’s results are based on the momentum oscillator. This indicator was established by Donald Lambert and its main purpose is to know when a trade is overbought or oversold.
This indicator uses the trend strength, and price trend direction to pinpoint the best time to exit or enter a trade. This indicator is used by both amateur and professional traders as a trade signal.
How Does CCI Work?
The CCI is mostly utilized in pinpointing new market directions, it indicates a trend’s weak point in a case of price divergence, and also it signals when a trade is overbought or oversold.
When the index shifts from negative (close to zero) and slides above 100, it signifies a new bullish trend. When this happens, it indicates it’s time for traders to look out for a price reversal. The CCI indicates a buy signal.
For a bearish trend, the above-stated events also occur. When the index slides below -100 from a positive reading (close to zero) it indicates the beginning of a bearish trend. This means it is time for traders to close their long trades and prepare to go short.
In a case of price divergence (when the price of an asset trend is contrary to the result of the indicator).
For instance, the price is falling but CCI keeps increasing, which means the trend is about to reverse to the upside.
However, this divergence is not a reliable trade signal. In some cases, the price won’t reverse, and it can last for a long time. This should be rather considered as a warning to traders.
For a trader on a long trade, When the price keeps increasing with CCI decreasing it means it’s time to close the position.
Additionally, in such cases, it is not advisable to add to present open positions.
How to Read the CCI Indicator
Buy signal – When the Index moves over +100 it is possible a buy signal. The beginning of a new and strong bullish trend.
Sell signal – When the Index moves below -100 it indicates the beginning of a new and strong bearish trend Indicates a sell signal
However, before opening trade positions based on these results, use other technical tools to confirm the trend results. This is because trading based on the results of one technical tool is not advisable.
Overbought – When the index reads above +100 it indicates an overbought trade.
Oversold – When the index reads below -100 it indicates an oversold trade.
The levels of this indicator are not constant. This means they can be personalized to suit the trader’s trading strategy. Traders who speculate on volatile securities, can use levels +200 and -200.
For less volatile securities levels +100 and -100 should be used
CCI Calculation
To estimate the CCI, first you need to pick how many periods the index will analyze.
20 periods is the most popular period used. It is advisable to use higher periods to reduce complexity and volatility.
To explain how this index can be calculated we will use the 20 periods.
Using a spreadsheet, trial the closing price, high price, and low price for the 20 periods and then calculate the basic value.
After the 20 periods, calculate the basic value.
After the 20 periods, add up the last 20 prices and divide by 20 to estimate the moving average(MA).
The mean deviation is estimated by deducting the (MA) from the average price for the previous 20 periods.
Add up only the +values of these numbers and divide the total by 20.
CCI Formula
CCI = (Average Price – SMA of AverageP) / (0.015 * MD)
Using the above formula
Insert the average price, the moving average, and the mean deviation to calculate the CCI reading.
Where:
- CCI = Commodity Channel Index
- AveP = Average Price = (High + Low + Close) / 3 (Also referred to as the Basic Price)
- The 0.015 is a constant that ensures the index value is within the +100 to -100 levels.
Conclusion This indicator is a good trade signal indicator. However, it is important to use it in conjunction with other technical tools for more accurate results. And just like every other technical analysis tool, this indicator does not guarantee a 100% successful rate.
