What is an indicator (CCI)?
CCI indicator or commodity channel indicator is a flexible indicator used to identify price trends or alert overbought and oversold levels.
The indicator was introduced in the magazine "Commodities" in 1980 and Donald Lambert was the one who developed it.
The author originally used CCI to identify cyclic cycles in the goods. But this indicator can be successfully applied to assets like stocks, electronic money, forex pairs, ..
Watch now: What is the forex market?
In general, CCI measures current prices against average prices over a given period of time. CCI is relatively high when prices are well above average, but relatively low when prices are lower than average.
In this way, CCI can be used to determine oversold or overbought levels.
Formula for calculating CCI indicator
The following formula for calculating the CCI index is provided by the author of this indicator:
CCI = (Average price - SMA20 of typical price) / (0.015 x Average deviation)
Explain the steps for calculating a CCI indicator:
- Average price = (Peak price + Bottom price + Closing price) / 3
- Calculate the simple moving average value SMA of the moving average. The commonly used initial time frame is 20 days. But now more often 14-day time frames are used.
- Get the absolute value of the Average Price and the 20-day SMA.
- Calculate the standard deviation of the SMA and 0.015 as a constant.
Today, at a time when the tools and analysis software are booming, the brothers performing this calculation are not very concerned. By applications like MT4 or MT5 will help you solve this problem. I gave the formula only to help you visualize how it is calculated.
How CCI indicator works
The CCI indicator measures the difference between current and average prices over a period of time. The indicator oscillates above or below 0. It moves into either positive or negative zones.
The index has an increase of over 100, which reflects a strong price action that could signal the start of an uptrend. Drops below -100 reflect weak price action that could signal the start of a downtrend.
About two-thirds of the CCI's values are in the range from -2 to 3. The remaining one third of the values are outside that range. This shows the weakness or power of price volatility.
This is a leading indicator, chart analysis can look for overbought, oversold conditions and heralded an average price reversal.
Similarly, bullish and bearish divergences can be used to detect early movements and to predict trend reversals.
Now, will guide you transactions in each case.
Use the CCI indicator in trend identification
Let's analyze the example of using the CCI indicator to identify trends:
The chart below uses a 20-day CCI. There are 4 trend signals over the past seven months (highlighted with green and red arrows). Checking out the chart, the CCI-20 is not suitable for long term signals.
Chart analysis should be performed on weekly or monthly time frames. As the asset in the illustration peaked on 11-01 then collapsed. CCI moves below -100 after the next 8 days to signal the start of a prolonged move.
The price then bottomed out on February 08. The CCI indicator moves above 02 on the following 100 days to signal the beginning of a prolonged correction. CCI does not capture the correct highs or lows. But it can help filter out insignificant moves and focus on bigger trends.
CCI triggered a bullish signal when prices rose above 60 in June. Some traders may have considered overbought.
With bullish signals, the focus is on bullish setups with a low risk reward ratio. Note that this asset regained about 60% of its previous fall and formed a bearish flag pattern by the end of June. The next surge on the trend line provides another bullish signal and indicates CCI alarm is still in boost mode.
Determine the overbought and oversold levels with the CCI indicator
Determining the overbought and oversold levels is quite difficult with the CCI indicator because:
- first, CCI is an unbound oscillator. In theory, there is no limit of increase or decrease. That is greater than 100 and possibly less than -100. This makes the assessment of overbought or oversold subjective.
- Monday, asset prices may continue to rise higher after the CCI is overbought. Similarly, the asset price may continue to drop after the CCI indicator is overbought.
The definitions of overbought and oversold are different for the Commodity Channel Index (CCI). Also having values of -200 and 200 is a much harder level to achieve and represents an actual overbought, oversold level.
The chart below is the GOOG property and the use of the CCI-20 day indicator. The horizontal lines at -200 and 200 have been added to the chart.
From early February to early October, CCI has exceeded the level of 2 more than 10 times. The red dashed lines showing the CCI move back below 200. The blue dashed lines show when the CCI moves back above -4.
As you can see, this is a model and the signal is not clear. Note, GOOG continues to go higher even after the CCI is overbought in mid-September and moves below -9.
Bullish and Bearish divergences
- An increase divergence occurs when prices make a lower low. And CCI indicator created a new high, which shows less downtrend.
- A bearish divergence forms when the price records create a new high. And CCI formed a new lower peak, indicating less upward momentum.
Before too much confidence in divergence are reversal indicators, be aware that divergence can be misleading in a strong trend.
For example: A strong uptrend may show many bearish divergences before a new peak is formed. In contrast, bullish divergences often appear in long-term downtrends.
While divergences can herald a trend reversal. Chartists should set a confirmation point for either a CCI or a price chart.
A bearish divergence can be confirmed with the CCI breaking below zero or breaking support on the price chart. Similarly, a bullish divergence can be confirmed with the CCI breaking above the 0 level or breaking the resistance zone on the price chart.
The chart below uses 40-day CCI. Longer time frame to reduce price volatility. There are three fairly large divergences over a 7-month period.
First, the price pushed to a new high in early May. But the CCI indicator did not exceed the highest level in March and formed a bearish divergence. A support breakout of the price chart and the CCI moving into the -5 zone confirm divergence a few days later.
Next, a bullish divergence formed in early July when prices moved to a lower low. But CCI forms a higher low. This difference was confirmed when CCI moved up to the zone 7.
Also note that asset prices filled the gap (Filled GAP) at the end of June with a spike in early July.
Finally, a bearish divergence formed in early September and was confirmed when the CCI entered the -9 zone. Despite CCI confirmation, the price never broke support and the divergence did not lead to trend reversals.
So it can be said that: Not all divergences produce good signals. Depending on the case as analyzed offline.
Explain the symbol on a chart:
- Higher high: Higher peak.
- Filled gap: Filling the gap.
- Lower low: Lower bottom
- Confirmation: Confirmation
- Bearish divergence: Divergence declines
- Bullish divergence: Increasing divergence
So, to summarize a few points you learned through the analysis using the CCI indicator:
CCI (Commodity Channel Indicator) is an oscillating indicator that helps you determine the price of an asset's high or low. Can indicate weakness or end of a trend. Thereby helping you to join the trade as soon as the trend starts or exit the trade before it goes against you ...
Finally, combine the CCI with the indicators Blogtienao mentioned. All indicators are fully provided on the website. The article is not investment advice, do your own research and evaluation. Thanks!