What this means, in essence, is that along the way, traders are bombarded with a multitude of dense indicators supposedly to tell market trends. Many struggle to find some type of reliable tool that is simple, yet effective in determining overbought and oversold conditions in various markets.
Commodity Channel Index CCI is a momentum oscillator. It was proposed by Donald Lambert in 1980. Though the indicator was first built for commodities futures markets, its simplicity combined with flexibility proved to be so attractive that now it is widely used by traders in all markets: stocks, forex, and so on.
The Commodity Channel Index, its calculation, and the usage of proper settings with successful trading strategies will be explained in detail in this article. Be you a novice or seasoned trader, here you will learn how to use CCI in order to identify trends of the market and take profit from your trade.
What is the Commodity Channel Index?
The Commodity Channel Index is a momentum-based technical indicator indicating a security price against its historical average. It contains both positive and negative values, fluctuates around zero, and it is used to identify overbought, oversold, or neutral conditions in an asset.
Key Values:
- CCI over +100: the market is overbought.
- CCI below -100: Indicates that the market is oversold.
- CCI between +100 and -100: Indicates a neutral market.
It gains strength in its capability to capture both trend-following and mean-reversion strategies, making it versatile enough to accord with various trading environments.
How Is the Commodity Channel Index Calculated?
Although the formula behind the CCI may look complex, it essentially compares the current price of an asset to its average over a specified period. Here’s how it works:
- Typical Price: Calculate the average of an asset’s high, low, and close prices for each period:scssCopy code
Typical Price (TP) = (High + Low + Close) / 3 - Moving Average: Compute the simple moving average (SMA) of the typical price over a selected period (usually 20):
SMA = Sum of typical prices over 'n' periods / 'n' - Mean Deviation: Determine the mean deviation by calculating the average absolute difference between the typical price and the SMA.
- Final Calculation: The CCI formula is completed as:
CCI = (Typical Price - SMA) / (0.015 * Mean Deviation)
This formula normalizes the index, allowing it to oscillate between positive and negative values, and helping traders gauge whether the current price is significantly higher or lower than its average.
Commodity Channel Index CCI Best Settings
Although traditionally, the CCI sets the default to 20 periods, it may be adjusted according to your trading style and the underlying asset you are trading.
Short-term trading:
It is good for the short-term trader who is looking to catch the quick swings in price. The setting makes the CCI more responsive to the recent changes in price that the trader can capitalize on for the short-term momentum.
Longer-term traders:
Might smooth the CCI over 30-50 periods, which serves to filter out some of the noise and focuses on larger trends. This setting works well also for identifying more substantial overbought and oversold conditions.
Pro Tip:
Experiment with different periods, then backtest them on your chosen asset to see what setting works best for the signals you’re trying to get for your strategy.
CCI Trading Strategy: Breakouts of Trends
Probably the most popular way to use the commodity channel index for trade is in trend breakouts. It is important because this strategy takes advantage of the indicator’s ability to signal that a market is entering into a strong trend. Here’s how it works:
Bearish Trend Breakout:
- SELL Entry Point: When the CCI breaks below -100, it gives an indication of the market being oversold, hence the beginning of a downtrend. This is indicative to sell the asset.
- Stop Loss: Put the stop loss above the previous swing high in order to guard against reversal.
- Take Profit: Once at least a 1:2 risk-to-reward ratio is achieved, place a take-profit level. Alternatively, the trader may let the trade run, allowing the CCI to re-enter the neutral territory above -100 in order to catch more of the trend.
Bullish Trend Breakout:
- Entry Point: The CCI crosses above the upper barrier of +100, which indicates upward momentum in the underlying. This forms a buy point of the asset.
- Stop Loss: Place stop loss below the previous swing low.
- Take Profit: As already mentioned in the bearish break-out strategy, aim for a 1:2 risk-to-reward ratio, or when CCI shows its reading below the +100 line back to neutral territory.
It is a good breakout strategy that works well when applied to trending markets, whereby the CCI confirms the strength of the trend.
CCI Trading Strategy: Range-Bounded Markets
It only trends about 30% of the time, and so, when the market is sideways, range-bound trading strategies become paramount. It is under these conditions that the CCI works best, showing overbought and oversold levels by which traders will sell peaks and buy valleys.
Peaks Selling:
- Entry Point: If the CCI peaks above +100 and then starts to decline, an overbought market is indicated. This could contain the potential to sell the asset.
- Stop Loss: Place your stop loss above the most recent swing high.
- Take Profit: Aim for conservative profit targets, such as 1:1 or 1:2 risk to reward. You are not looking for the big directional moves but rather a mean reversion.
Buying Valleys:
- Entry Point: If the CCI falls below -100 and then begins to rise upwards, this will mean over-sold conditions of the market. Therefore, now is the time to buy the asset.
- Take Profit/Stop Loss: Put your stop loss below the recent swing low.
- Take Profit: Place your take-profit level at a conservative 1:1 or 1:2 risk-to-reward ratio. You want to take advantage of the price bouncing back into neutral territory.
Advantages in Using Commodity Channel Index – CCI
There are several benefits that stem from the use of CCI in a trading strategy.
- User-Friendly: CCI is easy to understand and trade, thus it suits any level of trader.
- Strategic flexibility: CCI is equally effective in trending and range-bound markets, offering numerous trading opportunities.
- Complementary: The CCI works well in combination with other indicators such as moving averages, pivot points, or Fibonacci levels. This improves your overall trading strategy.
- Free and Available: Most trading platforms still provide the CCI, and it’s enormously customizable.
Conclusion
The CCI is a very versatile and potent overbought/oversold indicator that a commodity trader could put into use. Whether one is trading commodities, stocks, or forex, the CCI will enable you to make better decisions based on capturing momentum shifts or trend strength. You can build a truly robust trading strategy for both trending and range-bound markets by having the best settings for your trading style, combined with using the CCI with other indicators.
