Commodity Channel Index (CCI)

The Commodity Channel Index (CCI) is an oscillator originally introduced by Donald Lambert in an article published in the October 1980 issue of Commodities magazine (now known as Futures magazine).
Since its introduction, the indicator has grown in popularity and is now a very common tool for traders in identifying cyclical trends not only in commodities, but also equities and currencies. The CCI can be adjusted to the timeframe of the market traded on by changing the averaging period.

Calculation

There are 4 steps involved in the calculation of the CCI:
  1. Calculate the last period's Typical Price (TP) = (H+L+C)/3 where H = high, L = low, and C = close.
  2. Calculate the 20-period Simple Moving Average of the Typical Price (SMATP).
  3. Calculate the Mean Deviation. First, calculate the absolute value of the difference between the last period's SMATP and the typical price for each of the past 20 periods. Add all of these absolute values together and divide by 20 to find the Mean Deviation.
  4. The final step is to apply the Typical Price (TP), the Simple Moving Average of the Typical Price (SMATP), the Mean Deviation and a Constant (.015) to the following formula:
CCI = ( Typical Price - SMATP ) / ( .015 X Mean Deviation )

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Interpretation

Traders and investors use the Commodity Channel Index to help identify price reversals, price extremes and trend strength. As with most indicators, the CCI should be used in conjunction with other aspects of technical analysis. CCI fits into the momentum category of oscillators. In addition to momentum, volume indicators and the price chart may also influence a technical assessment. It is often used for detecting divergences from price trends as an overbought/oversold indicator, and to draw patterns on it and trade according to those patterns. In this respect, it is similar to Bollinger bands, but is presented as an indicator rather than as overbought/oversold levels.

The CCI typically oscillates above and below a zero line. Normal oscillations will occur within the range of +100 and -100. Readings above +100 imply an overbought condition, while readings below -100 imply an oversold condition. As with other overbought/oversold indicators, this means that there is a large probability that the price will correct to more representative levels.

The CCI has seen substantial growth in popularity amongst technical investors; today's traders often use the indicator to determine cyclical trends in not only commodities, but also equities and currencies.
The CCI, when used in conjunction with other oscillators, can be a valuable tool to identify potential peaks and valleys in the asset's price, and thus provide investors with reasonable evidence to estimate changes in the direction of price movement of the asset.

Lambert's trading guidelines for the CCI focused on movements above +100 and below -100 to generate buy and sell signals. Because about 70 to 80 percent of the CCI values are between +100 and -100, a buy or sell signal will be in force only 20 to 30 percent of the time. When the CCI moves above +100, a security is considered to be entering into a strong uptrend and a buy signal is given. The position should be closed when the CCI moves back below +100. When the CCI moves below -100, the security is considered to be in a strong downtrend and a sell signal is given. The position should be closed when the CCI moves back above -100.

Since Lambert's original guidelines, traders have also found the CCI valuable for identifying reversals. The CCI is a versatile indicator capable of producing a wide array of buy and sell signals.
  • CCI can be used to identify overbought and oversold levels. A security would be deemed oversold when the CCI dips below -100 and overbought when it exceeds +100. From oversold levels, a buy signal might be given when the CCI moves back above -100. From overbought levels, a sell signal might be given when the CCI moved back below +100.
  • As with most oscillators, divergences can also be applied to increase the robustness of signals. A positive divergence below -100 would increase the robustness of a signal based on a move back above -100. A negative divergence above +100 would increase the robustness of a signal based on a move back below +100.
  • Trend line breaks can be used to generate signals. Trend lines can be drawn connecting the peaks and troughs. From oversold levels, an advance above -100 and trend line breakout could be considered bullish. From overbought levels, a decline below +100 and a trend line break could be considered bearish.
Example

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The 20-day CCI for Brooktrout (BRKT)  provides an example using Lambert's guidelines. Even though a few signals are good, using crosses above and below +100/-100 resulted in plenty of whipsaws. In January, the stock broke resistance at 20, and proceeded to double in the next few weeks. The CCI moved above and below +100 several times, but the stock remained in a strong uptrend. The CCI did manage to remain above +50 for about 7 weeks (blue oval), but the whipsaws below +100 could have caused an early exit. Whipsaws do not make an indicator bad. However, traders and investors should learn to use the CCI in conjunction with other indicators and chart analysis. In addition, various time frames for the CCI should be tested, and you should test buy and sell points, as well. What works for one stock may not necessarily work for another stock. For Brooktrout, a buy point on a cross above and below +50 may have worked better.


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