Hello friends. In previous articles, I talked about the
importance of technical indicators as a part of technical analysis. Technical
indicators are the most important tools
we need when trading in financial markets. Today, we will discuss another
technical indicator, the Commodity Channel Index (CCI) indicator.
What is the Commodity Channel Index (CCI) indicator?
The Commodity Channel Index (CCI) is a momentum indicator
that measures how far a price of an asset deviates from its average price. The
CCI indicator was created by Donald R. Lambert in the early 1980s. Lambert
developed this indicator to provide commodity market traders with an analytical
tool to support their trading decisions. The CCI indicator can be used not only
in commodity markets but also in other financial markets. It is commonly used
to identify overbought and oversold conditions in markets such as stocks,
commodities, and other financial instruments. Aside from this, the CCI
indicator can be employed to determine trends, identify overbought and oversold
levels, and establish support and resistance levels. This indicator tracks
price movements and deviations by using the moving average of the typical
price.
Calculation of Commodity Channel Index (CCI)
The standard setting for CCI is 20, which means CCI measures
price changes over a 20-day period. However, different settings can be used.
For instance, a 14-day CCI might be more responsive, while a 50-day CCI could
be less sensitive. The optimal setting for CCI depends on the trader's
preferences and trading style. The values of the CCI indicator range from 0 to
100. Values above +100 are considered overbought, while values below -100 are
considered oversold. The calculation formula for the Commodity Channel Index
(CCI) is as follows:
CCI = (TP - SMA) / (0.015 * MAD)
Here are the terms used in this formula:
- TP (Typical Price): TP represents the typical price and is often calculated as follows: TP = (High Price + Low Price + Closing Price) / 3.
- SMA (Simple Moving Average): SMA is the simple moving average of the typical price over a specific period. It is calculated by taking the sum of the typical prices over a given time frame and dividing it by the total number of time periods. For example, if you want to calculate a 20-period CCI, you would sum the last 20 typical prices and divide by 20.
- MAD (Mean Absolute Deviation): MAD represents the sum of the absolute values of price changes above or below the moving average of the typical price. In other words, it measures how much each typical price deviates from the moving average when comparing the two.
The CCI indicator oscillates between 100 and -100 levels as
a result of these calculations. A CCI value above 100 indicates overbought
conditions, while a value below -100 indicates oversold conditions. Therefore,
CCI is an indicator used to identify overbought and oversold conditions and
potential reversals.
Trade with the Commodity Channel Index (CCI)
We use the Commodity Channel Index (CCI) to analyze price
movements on a given timeframe and identify possible trading signals. Different
strategies can be developed to generate buy and sell signals with the CCI.
Let's look at two of the most common strategies:
Turning Signals from Overbought and Oversold Zones. When CCI
rises above 100 and then reverses, it can be a sell signal. This suggests that
a reversal or pullback may occur after overbought conditions. If CCI reaches
-100 or lower and then the downward trend reverses, it can be considered a buy
signal. This indicates a possible reversal after oversold conditions. See the
example on the daily chart of Natural Gas below:
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| CCI trading Natural Gas daily chart example |
Divergence Analysis. Monitoring divergences between CCI and
prices can also assist in generating buy and sell signals. For instance, if CCI
is rising while prices are falling, this can be interpreted as a positive divergence and a buy signal. Conversely, if CCI is falling while prices are
rising, this can be seen as a negative divergence and a sell signal. See the
example on the 4-hour chart of Brent Oil below:
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| Trading Opportunities Using CCI Divergences |
Please note that trading in financial markets carries risks. It's important to maintain emotional control during trading. Avoid making hasty decisions and refrain from emotional-based trades. Like all other technical indicators, the CCI indicator has limitations and can produce false signals. CCI should not be used as a standalone trading strategy. Consider other technical analysis indicators, candlestick patterns, support and resistance levels, and combine CCI with them to obtain more reliable results.