What Is the Commodity Channel Index (CCI)?
The Commodity Channel Index (CCI) is a momentum-based oscillator used to help determine when an investment vehicle is reaching a condition of being overbought or oversold.
Developed by Donald Lambert, this technical indicator assesses price trend direction and strength, allowing traders to determine if they want to enter or exit a trade, refrain from taking a business, or add to an existing position. In this way, the indicator can provide trade signals when it acts in a certain way.
The CCI is categorized as a momentum oscillator, which means that CCI is used to identify overbought and oversold levels.
The CCIindicator's fundamental assumption is that commodities move in cycles, with highs and lows coming at periodic intervals.
The CCI indicates when one of those cyclical reversals is imminent.
While Lambert initially used CCI to trade commodities, the indicator is used across different assets nowadays.
How Commodity Channel Index (CCI) Works
The Commodity Channel Index (CCI) measures the current price level relative to an average price level over a given period.
The CCI fluctuates above and below zero.
- CCI is relatively high when prices are far above their average.
- CCI is relatively low when prices are far below their average.
Using this method, CCI can be used to identify overbought and oversold levels.
The percentage of CCI values that fall between +100 and -100 will depend on the number of periods used.
- A shorter CCI will be more volatile with a smaller percentage of values between +100 and -100.
- The more periods used to calculate the CCI, the higher the percentage of values between +100 and -100.
Lambert’s trading guidelines for the CCI focused on movements above +100 and below -100 to generate buy and sell signals.
Because about 70 to 80 percent of the CCI values are between +100 and -100, a buy or sell signal will only generate 20 to 30 percent of the time.
- When the CCI moves above +100, the price is considered to be entering into a strong uptrend, and a buy signal is given.
- The position should be closed when the CCI moves back below +100.
- When the CCI moves below -100, the price is considered a strong downtrend, and a sell signal is given.
- The position should be closed when the CCI moves back above -100.
How to Use the Commodity Channel Index (CCI)
The CCI is a versatile indicator and can be used in different ways.
Overbought and Oversold Levels
CCI is used to identify overbought and oversold levels.
- An asset is considered oversold when the CCI falls below -100.
- From oversold levels, a buy signal might be given when the CCI moves back above -100.
- An asset is considered overbought when the CCI rises above +100.
- From overbought levels, a sell signal might be given when the CCI moves back below +100.
As with most oscillators, divergences between the indicator and the actual price action can also be applied to increase the strength of signals.
- A positive divergence below -100 would increase the strength of a signal based on a move back above -100.
- A negative divergence above +100 would increase the strength of a signal based on a move back below +100.
CCI Trend Line Breaks
Trend line breaks can be used to generate signals. Trend lines can be drawn connecting the peaks and troughs.
- From oversold levels, an advance above -100 and trend line breakout is considered bullish.
- From overbought levels, a decline below +100 and a trend line break is considered bearish.
Traders use the CCI to help identify price reversals, price extremes, and trend strength.
As with most technical indicators, the CCI should be used in conjunction with other forms of technical analysis.
How to Calculate the Commodity Channel Index (CCI)
The proper calculation of the CCI requires several steps.
They are listed in the proper sequence below.
It would help to compute the typical price using the high, low, and close intervals. It is the simple arithmetic average of the three values.
The formula is:
TP = (High + Low + Close) / 3
- TP represents the typical price.
- High is the highest price for this interval.
- Low is the lowest price for this interval.
- Close is the closing price for this interval.
Next, you calculate a simple moving average of the typical price for the number of periods specified.
TPAVG = (TP1 + TP2 +... + TPN) / n
- TPAVG is the moving average of the typical price.
- TP is the typical price for the nth interval.
- N is the number of intervals for the average.
The next step is rather complex; it computes the mean deviation. The formula is:
MD = (|TP1 - TPAVG1| +... + | TPn - TPAVGn |) / n
- MD is the mean deviation for this interval.
- TPN is the typical price for the nth break.
- TPAVGn is the moving average of the regular price for the nth break.
- N is the number of intervals.
The symbol | | designates absolute value. In mathematical terms, negative differences are treated as positive values.
Now, the computation for the final CCI value is:
CCI = (TPt - TPAVGt) / (.015 * MDT)
- CCI is the Commodity Channel Index for the current period.
- TPI is the typical price for the current period.
- TPAVGt is the moving average of the typical price.
- .015 is a constant.
- MDT is the mean deviation for this period.
For scaling purposes, Lambert set the Constant at .015 to ensure that approximately 70 to 80 percent of CCI values would fall between -100 and +100.