What is Commodity Channel Index?
The Commodity Channel Index (CCI) is a technical indicator that can identify overbought or oversold levels in market conditions as well as potential trend reversals and trade signals. It can also be used in conjunction with other technical analysis indicators to get confirmed market signals. Let's take a look at the indicator in-depth and learn how you can trade with it.
What is the Commodity Channel Index (CCI)?
CCI is a momentum oscillator that can identify the market direction and its strength. The indicator measures the difference between the current price and the historical average price to determine overbought and oversold levels. The values of CCI oscillate between +100 and -100 around a zero line.
- When the CCI is positive (above the zero line), it indicates that the prices are above the moving average and the market tends to be overbought.
- When the CCI is negative (below the zero line), it indicates that the prices are below the moving average and signals for 'oversold' in the markets.
This graph has been recreated from the original source. Please note this image is a representation only and is not provided as general or personal advice.
Trading signals provided by CCI indicator
Bullish/bearish divergences
Divergences are a potential reversal signal in the market. A bullish divergence occurs when the currency pair price makes a lower low, but the CCI makes a higher low. The divergence is confirmed when the currency pair price line breaks below zero on the CCI chart or the support on a price chart. On the other hand, a bearish divergence occurs when the currency pair price makes a higher high but the CCI makes a lower high. The divergence is confirmed when the currency pair price breaks above zero on the CCI chart or the resistance on the price chart.
This graph has been recreated from the original source. Please note this image is a representation only and is not provided as general or personal advice.
New trends
CCI can determine the current trend direction by analysing the CCI value. If the CCI is above zero and rising, this indicates a continuous uptrend. If the CCI is below zero and falling, this indicates a continuous downtrend. After determining the trend direction, the next step is to look for trendline breaks. Drawing trendlines connecting the CCI's highs or lows can help identify potential trend reversals. When the CCI breaks through a trendline, it signals a potential trend reversal and the emergence of a new trend.
This graph has been recreated from the original source. Please note this image is a representation only and is not provided as general or personal advice.
Trend interpretation
CCI also helps in interpreting the strength of a trend. It measures the difference between the currency pair’s price change and the average price change. A high positive reading indicates that the current prices are above the average prices and that the current trend is strong. On the other hand, when the readings are low and negative, the current prices are below their average, indicating a weak trend.
This graph has been recreated from the original source. Please note this image is a representation only and is not provided as general or personal advice.
How to calculate CCI?
- Determine the number of periods in which you want to analyse the CCI. 20-periods* is a typical range for a smooth calculation.
- Track the high, closing, and low prices for the 20-periods* of the currency pair to compute the typical price.
- Calculate the moving average of the typical price by adding the last 20 typical prices and dividing it by 20.
- Calculate the mean deviation for the 20-periods* by subtracting the moving averages from the typical price for the previous 20-periods*. Add the absolute values and divide them by 20.
- Consider the most recent typical price, moving average and mean deviation into the formula that we will mention below. This will be the current CCI reading.
- Repeat the process after the end of each new period.
*The variable is not fixed. Traders need to adjust the calculation if they want to use a different number. CCI = (Typical Price - n-period Simple Moving Average of Typical Price) / (0.015 * Mean Deviation) Where:
- Typical Price = (High + Low + Close) / 3
- n-period Simple Moving Average of Typical Price = Sum of the Typical Prices over the past n periods divided by n.
- Mean Deviation = Mean Absolute Deviation of the Typical Price over the past n periods.
- 0.015 is a constant value used to normalise the CCI and make it comparable across different assets and timeframes.
It is important to note that different traders may employ use slightly different variations of the CCI formula, and that the parameters used may need to be adjusted depending on market conditions and trading strategy.
A step-by-step guide on how to trade with the CCI indicator
- Add the CCI indicator to your forex chart.
- Adjust the CCI indicator settings to suit your trading style. The default setting is usually 14 or 20 periods, but you should adjust it to suit your personal preferences.
- Identify the overbought and oversold levels on the CCI indicator. The default levels are +100 and -100, but you can adjust them to suit your preferences*.
- Look for divergence between the CCI indicator and the price action. If the CCI indicator is making higher highs while the price is making lower highs, it is a bearish divergence, and you should look for a short entry. If the CCI indicator is making lower lows while the price is making higher lows, it is a bullish divergence, and you should look for a long entry.
- Use the CCI indicator to confirm your trade entry signals. For example, if the price breaks out of a resistance level and the CCI indicator is above +100, it is a strong buy signal.
- Use the CCI indicator to set your stop loss and target levels. For example, if you plan to go long, set your stop loss below the oversold level (-100) and your target level above the overbought level (+100).
- Manage your trade using the CCI indicator and exit the trade when positions are in your favour.
*We do not give personal advice. You should carefully consider your objectives, financial situation, needs and level of experience before entering into any margined transactions.
Add the CCI indicator to your forex price chart now
The CCI indicator is a useful tool that helps spot divergences, identify overbought/oversold market levels and trading signals. Start trading with Blueberry Markets. Sign up for a live account or try a demo account.
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