Commodity Channel Index Indicator: Full Guide

Momentum indicators

Commodity Channel Index
  • The Commodity Channel Index is a momentum-based indicator.
  • It helps traders determine when an investment vehicle gets to a condition of being overbought or oversold.
  • This information makes it possible for traders to know if they want to enter or leave a trade.

The Commodity Channel Index (CCI) is a popular indicator traders use in the technical analysis of financial markets. The oscillator group of technical indicators is where the indicator belongs to and is a momentum-based indicator.

What is the CCI indicator history?

Donald R. Lambert created it. A technical analysis journal first published his work and details of the indicator, referred to as Commodities in 1979. Lambert was not a trader but came from an academic background. He had degrees in mathematics, Statistics, and Accounting. The degrees helped him in creating the commodity channel index.

Lambert made the CCI detect the cycles in the commodity markets. This is where the indicator gets the name “Commodity.”

As a momentum-based indicator, the CCI index belongs to the oscillator group of indicators. These indicators move around fixed values and can show changes in momentum or volume. The most common values of the oscillator range from 0 to 100, or -100 to +100. The CCI on the other hand is unbounded (it has no upper or lower limit).

Traders keep such indicators in the sub-window below the price chart. People use them in forex trading (among others) to mainly determine overbought and oversold signals in the market. But there are also other ways to use them. 

Apart from detecting overbought and oversold situations, you can also use the CCI in trading to measure the strength of the trend. Forex traders also use the indicator to warn about extreme market conditions.

Many beginners in trading mostly apply a technical indicator using uniform rules. Traders then blindly use the rules regardless of whether the markets are trending or ranging. This is why most beginners complain that indicators such as the commodity channel index do not work as expected.

What is the Commodity Channel Index (CCI)?

The Commodity Channel Index is a momentum-based indicator. It helps traders determine when an investment vehicle gets to a condition of being overbought or oversold. This information makes it possible for traders to know if they want to enter or leave a trade. It also tells them when to refrain from taking a trade, or add to an existing position. Traders can use the indicator to get trade signals when it acts in a particular manner.

The commodity channel index indicator is an oscillator used to determine cyclical trends in security. The CCI is more of a momentum indicator when it oscillates above and below the zero lines, because there is no upward or downward limit on its value. The default time for the CCI indicator is 14 periods, just as the RSI and Stochastics Indicators. If you decide to use a shorter setting, the number of signals and sensitivity of the indicator will increase.

How to trade using the Commodity Channel Index Oscillator

Traders have now begun to not only use the CCI to trade commodities, but also for stocks. Generally, oversold is –100 and overbought +100. While traders will look for divergences in the CCI and the price trend, trend line breaks of the CCI are also common. 

How does this indicator work?

When the CCI moves higher than +100, a new, strong uptrend is on the way, signaling a buy. Use trending indicators or other technical analysis methods to confirm signals indicated by the CCI.

When the CCI moves lower than −100, a new, strong downtrend is starting, indicating a sell. Close the position on CCI rising above −100. You can use trending indicators or other technical analysis methods to confirm signals indicated by the CCI.

Look for overbought levels higher than +100 and oversold levels less than -100. Traders can adjust these CCI values depending on the volatility of the security. For instance, for more volatile security, you can use +200 and -200.

Remember that CCI is an unbound oscillator. This means that there are no upside or downside limit. This makes interpreting an overbought or oversold condition subjective. When the CCI is overbought the security can continue to move higher. When the CCI is oversold the security can continue lower as well. 

Make use of the CCI together with other technical tools when attempting to read overbought or oversold conditions.

If underlying prices make a new high or low that is not confirmed by the CCI, the divergence may indicate a price reversal.

What does the CCI indicator tell traders?

The CCI is mainly used for detecting new trends, watching for overbought and oversold levels, and detecting weakness in trends when the indicator diverges with the price.

The price is starting a new uptrend when the CCI goes from negative to above 100. Once this happens, traders can notice for a pullback in price, then a rally in both price and the CCI to indicate a buying change.

The same concept applies to an emerging downtrend. When the indicator moves from positive readings to below -100, then a downtrend may start. This is a signal to get out of longs or to start watching for shorting opportunities.

Overbought and oversold levels are not fixed since the indicator is unbound. Thus, traders look to past readings on the indicator to get a sense of where price reversed. For one stock, it may tend to reverse close to +200 and -150. For another, it may reverse close to +325 and -350. Always zoom out on the chart to see lots of price reversal points, and the CCI readings.

There are also divergences. This is when the price is moving one way but the indicator is moving another. A weakness in the trend happens when the price is increasing and the CCI is decreasing. 

While divergence is a poor trade signal since it can last a long time and does not always lead to a price reversal. It can be good for at least warning the trader that there is the possibility of a reversal. By doing this, they can tighten stop-loss levels or hold off on taking new trades in the price trend direction.

What period is used to calculate the Commodity Channel Index?

Determine how many periods your CCI will analyze. Traders commonly use the 20 period. Lesser periods lead to a more volatile indicator, while more periods will make it smoother.

The difference between the Commodity Channel Index (CCI) and the Stochastic Oscillator

Both of these technical indicators are oscillators, people calculate them differently. One of the major differences is that the Stochastic Oscillator is bound between zero and 100, while nothing binds the CCI. Because of the calculation differences, they will give varying signals at various times, such as overbought and oversold readings.

Limitations of using the Commodity Channel Index Indicator 

Although they are often used to detect overbought and oversold conditions, the CCI indicator is highly subjective in this regard. The indicator is unbound and therefore, prior overbought and oversold levels may have little impact in the future.

The indicator is also lagging. This means that sometimes, it will give poor signals. A rally to 100 or -100 to signal a new trend may come too late, as the price has had its run and is beginning to correct already. Traders refer to such incidents as whipsaws. 

The indicator provides a signal but the price doesn’t follow through after the trader loses signal and money. Whipsaws can happen if not careful. Thus, the indicator is best used together with price analysis and other forms of technical indicators to help confirm or reject CCI signals.

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