What is commodity channel index (CCI)?
The Commodity Channel Index (CCI) developed by Donald Lambert, is a popular technical indicator used by traders to identify overbought or oversold conditions in the market. It measures the deviation of price from its statistical average. Traders use this indicator to identify potential trend reversals, identify new trends, and determine entry and exit points.
The formula to calculate CCI involves taking the difference between the typical price (average of high, low, and closing prices) and the simple moving average (SMA) of the typical price over a set period (usually 20). This difference is then divided by a constant multiple of the mean deviation (a measure of volatility) of the typical price. The resulting value is plotted on a chart.
When the CCI moves from negative or near-zero territory to above 100, that may indicate the price is starting a bullish trend. Once it happens, traders can watch for a pullback in price followed by a rally in both price and the CCI to signal a buying opportunity.
When the indicator goes from positive or near-zero readings to below -100, then a downtrend may be starting. This is a signal to get out of longs or to start watching for shorting opportunities.
How to trade with commodity channel index (CCI)?
Let's demonstrate how to use CCI with an example scenario. Suppose you are a swing trader and are monitoring the price of a particular stock. You notice that the stock has been in a downtrend for the past few weeks, but you suspect that a reversal may be imminent. To confirm your suspicions, you decide to use the CCI indicator.
After calculating the CCI value for the past 20 periods, you notice that the current value is -150, indicating that the stock is oversold. This signals to you that a potential reversal may be on the horizon, so you decide to enter a long position.
Over the next few days, the stock price begins to rise, and the CCI value gradually increases. After several days, the CCI value reaches 50, indicating that the stock is no longer oversold. You decide to exit your long position, having made a profit from the trade.
It is important to note that CCI is not infallible and should not be used in isolation. Traders should use it in conjunction with other indicators and analysis techniques to confirm signals and minimize the risk of false positives.