The Commodity Channel Index oscillator measures the position of a currency’s price with respect to its moving average. This is useful for traders as it can be used to highlight when the market is overbought or oversold or to help signal when a trend is weakening. Despite its name the indicator is also widely used in the currency and equities markets.
Below is an example based on a 20-period Commodity Channel Index (CCI) calculation. The number of CCI periods is also used for the calculations of the simple moving average and Mean Deviation.
CCI = (Typical Price - 20-period SMA of TP) / (.015 x Mean Deviation)
Typical Price (TP) = (High + Low + Close)/3
Constant = .015
There are four steps to calculating the Mean Deviation.
- Subtract the most recent 20-period average of the TP from each period's TP.
- Take the absolute values of these numbers.
- Sum the absolute values.
- Divide by the total number of periods (20).
Trading with the Commodity Channel Index
The Commodity Channel Index (CCI) indicates when a price is high or low compared to its statistical average, this helps traders gain insight into how extreme the current price action is in context of the past price action. It is used as an overbought/oversold indicator similar to other indicators such as the Relative Strength Index (RSI). Overbought and oversold indicator lines are placed at 100 and -100 respectively. The CCI can be a highly volatile indicator, which can cause numerous whipsaw trades, it is therefore important to exercise disciplined risk management strategies when utilizing it.
Buy signals are given if the CCI rises up through -100, the signal would typically be more reliable in ranging markets and if the CCI has spent a number of time periods under -100. Traders may also wish to buy again when the CCI rises up through +100 as the momentum gains instensity , covering longs when it falls back through +100.
Sell signals are given if the CCI moves down through 100, the signal would typically be more reliable in ranging markets and if the CCI has spent a number of time periods above 100. Traders may also wish to sell again when the CCI falls below -100 as the momentum gains intensity, covering shorts when it rises back through -100.
Divergence signals provide more powerful signals but occur less frequently, they are normally used to trade intermediate price cycles in a trending market. A buy signal is given when there is a bullish divergence between the CCI and price, sell signals are given when there is bearish divergence between the CCI and price.