Commodity Channel Index Trading Indicator
The original Analysis Toolbox articles discussed the various market cycles including trends and continuations. This part of the The Trader’s Indicator Series focuses on the Trading Indicator Toolbox, as we will discuss various indicators that are found on most trading platforms. We will discuss the indicator in the context of the chosen market, and if it resonates with you, please continue to do your own analysis with it. Trading successfully is all about feeling comfortable with a methodology and using that system repeatedly even when boredom sets in. I will be discussing indicators in alphabetical order that can be found on the MotiveWave platform. This week is the turn of the Commodity Channel Index. (for a free 2-week trial CLICK HERE)
Commodity Channel Index
The Commodity Channel Index (CCI) is an indicator which attempts to distinguish between trending and extreme markets. Even though the name suggests it applies only to commodities, it works on any market, from forex to stocks to commodities. Many indicators which determine trend are called directional indicators, meaning they show whether the market is in an uptrend or a downtrend. This indicator is more of an oscillator, as it measures the current price level relative to the average over a specified period. CCI is high when prices are above the average (overbought), and low when prices are below the average (oversold). The indicator was originally designed to identify long-term trend changes but has been adapted by traders to use on all time frames.
The CCI fluctuates around the zero line, with approximately 75% of the values falling between +100 and -100. About 25% of the values will fall above +100 or below -100, indicating strong trending markets. The longer the period, the more likely the CCI will remain inside the +100 to -100 range. A shorter CCI (10 periods for example) will be more volatile and provide a higher percentage outside of the range.
The S&P chart below compares both the 20- and 40-period CCI on the daily chart. On this daily chart, the 20-period CCI dips below -100 twice, but stays within the range on the 40-period CCI, producing less volatility with the 40-period CCI.
This illustrates the longer the period in the Commodity Channel Index calculations, the less frequent the trend changes which is why day traders prefer a more sensitive CCI calculation to provide more signals on the smaller time frames. For example, on the hourly chart below, using a 10-period CCI provides more signals than that of a 20-period CCI. While 20-period is standard, the trader can customize the period based on preference.
USING THE COMMODITY CHANNEL INDEX TOOL
To illustrate this tool, look at the 1-hour chart above of the S&P500 index. During sideways markets, using the Commodity Channel Index as an oscillator is acceptable, with the strategy of buying when CCI extends below -100 and selling when CCI extends above +100. One way to tell if the market is sideways is to look at the Daily time frame, in conjunction with the 1-hour chart. As an oscillator, the CCI operates as a leading indicator, and signals a reversion to the mean in a sideways market. This indicator frequently shows divergence at market tops and bottoms as well.
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