Oscillators are some of the most important indicators in the financial market. These oscillators are important because of their importance in identifying when markets are overbought and oversold. They are also useful when confirming a trend.
In this article, we will look at the commodity channel index and how you can use it in the financial market.
What is the CCI indicator?
The commodity channel index (CCI) was developed in 1980 by Donald Lambert. He published an intensive article about it in the commodities magazine after he observed unique patterns that gave him pointers when a new trend was forming or when there were extreme conditions.
Like most other indicators, the CCI was developed with a focus on the commodities market. Still, it can now be used to identify trends and countertrends in other markets like ETFs and stocks.
CCI Formula: How to calculate the Commodity Channel Index
As with all technical indicators, it is not always necessary to know how the CCI indicator is calculated. Most traders who use it don’t have any idea about how it is derived.
If you want to know, the following formular is used to get the CCI.
|CCI = (Typical price – 20-day SMA of TP) / (0.015 x Mean Deviation)
The TP is known as the Typical Price and is calculated by adding the high, low, and close and dividing the result by 3.
The 0.015 is known as the constant. The Standard deviation is calculated by first subtracting the most recent 20-day average of the TP from each period’s TP.
Second, you should take the absolute values of these numbers and then add these absolute values. Finally, divide this figure by the total number of periods.
As you can see, the price calculation can be very difficult for most people.
How to Use CCI when Trading
As mentioned before, the CCI measures the difference between the current price of an asset and its average change. A number that is high shows that price is above its average and a number that is low means that the price is below its average.
Therefore, the CCI can be used to identify an overbought or an oversold level. In most trading platforms like the MT4 the default period that is used is 14 (in our Ppro8 you will found 20, but of course you can change it).
Also, the CCI has three lines. These are -100, 100, and 0.
As you can see above, the price tends to recover when the CCI reaches below -100. It tends to fall when it reaches +100.
However, in between, you can see a lot of false signals. This is an indication that you should never use the CCI alone. It is always recommended that you combine it with other oscillators, volumes, and trend indicators. Doing this will help reduce the likelihood of a false signal.
Using CCI to find divergences
A divergence happens when the price of an asset is going in the opposite direction as the indicator. For example, a stock may be rising while the oscillator is falling. When this happens, it is usually a signal that a reversal is about to happen.
A good example of this is in the chart below. As you can see, the overall trend of the USD/SEK pair is upwards while the CCI is declining. Therefore, this is a sign that the upward rally is fading and that the price will break-out lower in due time.
While divergences are useful, the challenge is that they usually take a lot of time to form and develop.
As shown in the chart above, it has taken more than two weeks for this divergence pattern to emerge. To solve this challenge, we recommend that you combine the CCI with other oscillators like the Relative Strength Index (RSI) and the MACD.
Best settings for the CCI indicator
When using the CCI indicator, you only need to adjust the length or its duration. By default, most trading platforms provide 20 as the length of the indicator. However, it is recommended that you take time in a demo account testing various periods.
For example, if you are a day trader, you can try to use a shorter CCI like 10 or 8. Similarly, if you are a long-term trader, you can use a longer duration.
CCI vs RSI
CCI and RSI are both oscillators that can help you identify overbought and oversold levels and divergencies. The latter, however, is the most popular one. RSI simply measures the speed and change of price movements in the market.
Like the CCI, it ranges between zero and 100, with moves above 70 being the overbought and those below 30 being oversold. The chart below shows a 20-day CCI and a 20-day RSI in a chart.
The Commodity Channel Index (CCI) is a popular oscillator in the market. You can use to trade all assets, including stocks, currencies, and exchange-traded bonds. To use it well, we recommend that you spend a substantial amount of time in a demo account and testing different scenarios.