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The CCI indicator is suitable for commodity markets as well as for equities, Forex or other underlying instruments from the broad investment universe. It is therefore worth taking a look behind the scenes of this technical indicator.
Let’s start with how the indicator works.
What is the CCI indicator?
The CCI indicator measures the strength of a price movement. The indicator thus fits into the series of momentum indicators. For traders, this provides a statement about the current balance of power in the market at first glance.
If the bulls dominate the market, the indicator is above the value of 100; in the case of a bear market impulse, the indicator is in the range below -100.
The Commodity Channel Index oscillates around a zero line. This gives the investor a sense of the relative strength or weakness in the market. But how does the CCI achieve this meaningfulness?
How is the Commodity Channel Index calculated?
Like many other indicators, the CCI is based on a moving average. The moving average is compared with the current price. The “typical price” is determined at the beginning.
TP = (high + low + close) / 3
The next step is again very simple. We make a simple moving average of this price.
Moving average = sum of the typical prices / number of values
In the standard setting, the 14-day average is often calculated.
In the last step, the average variance of the typical price is calculated, and then the value of the CCI is determined in a final step.
Average variance = sum of the individual variances (amount (TP – moving average)) / number of values
CCI indicator = (typical price – moving average) / (0.15 x average deviation)
Donald R. Lambert used the 0.15 in the formula to make the majority of the values oscillate in a desired range between -100 and +100.
Interpretation of the CCI indicator
Of course the CCI can be used in different ways. From the use in day trading to the classical approach in very large time levels, everything is conceivable. You should adjust the setting of the CCI to the real cycles in the markets.
In a sideways market, high settings produce unnecessary false signals, while in trend markets especially small settings do not produce useful results.
The Commodity Channel Index as a breakout system
A possible trading system is created by setting clear rules on the indicator. For example, you could open long positions in a market if the indicator shows a value of over +100, indicating that a larger trend could be created. Conversely, a short signal would be given when the CCI shows values below -100. The entry into a new position will end the other position.
Detect overbought or oversold markets
Another application would be the identification of markets that have overheated. The oscillator is used similar to the RSI or Fast Stochastic to identify overbought or oversold markets. Values above the 100 mark are sold in this way and bought below the -100 mark. Thus, this interpretation represents the reversal of the breakout system.
Divergence analysis in the CCI
Last but not least, the CCI can of course be freely interpreted. Experienced traders pay particular attention to new highs or lows in the respective underlying instrument without the indicator confirming these extremes. This is an attempt to find weakness in the markets long before it even occurs. In this way, a clear advantage for one’s own trading should be created. In this way, one does not run after the money, but goes towards it.
Conclusion on the CCI indicator
The Commodity Channel Index, like many other technical indicators, is not a panacea for traders. This indicator also has weaknesses that only an experienced trader can compensate for. Nevertheless, the CCI indicator is a good support for market interpretation. Especially the divergence analysis is successfully applied by experienced traders.
The CCI indicator thus fits seamlessly into the series of useful trading tools, which, however, on their own rarely lead to lasting trading success. Therefore, the principle that traders should only use the CCI indicator in real money trading after a long period of observation and learning applies to this technical indicator as well.
For a more complex trading system, a so-called expert advisor, combinations of different indicators are often used. Especially for trend-following approaches, the MACD is often used.