the-commodity-channel-index-indicator

The Commodity Channel Index (CCI) is a popular indicator among traders for analyzing the financial markets.

It is a momentum indicator that belongs to the oscillator group of technical indicators.

Such indicator work by moving around fixed values, depicting the changes in volume or momentum.

The CCI indicator was discovered by Donald R. Lambert in 1979 to help traders identify the cycles in the commodity markets.

Although the CCI indicator was developed for analyzing commodity markets, it is widely used in forex and other financial markets.

In this article, I will help you know how to make money on Forex using the CCI indicator.

Let’s start…

What is the Commodity Channel Index (CCI) Indicator?

The CCI is one of the most popular indicators that attempt to offer buy and sell signals.

The indicator is also used by traders to identify the overbought and oversold levels within a price action.

The indicator oscillates between fixed levels of +100 and -100.

It is calculated such that 75% of price movement should be between +100 (overbought) and -100 (oversold).

You can also use it with the settings of +200 and -200 and a look back period of 14.

Once the CCI indicator rises above the standard +100 or falls below -100, it sends a signal of overbought and oversold positions in the market.

This indicator is available on most trading platforms by default, hence, you do not have to download it.

Consider the chart given below…

the-commodity-channel-index-indicator

The above chart shows the CCI indicator on a chart.

The indicator is located on the bottom of the price chart, and it has been pointed to by a red arrow marked as Commodity Channel Index (CCI) Indicator.

We earlier stated that the CCI indicator belongs to the group of oscillators used for measuring momentum.

So…

What is Momentum?

If you have ever studied physics, you know that momentum is the amount of motion in a moving body.

Momentum is measured using mass and velocity.

So, how is physics related to forex?

Let me show you how…

The definition of momentum in forex is slightly different to the definition of momentum in physics.

However, the concept is still the same in both.

In finance, momentum is the tendency for a currency pair’s price that is rising to continue rising, or a falling currency pair’s price to continue falling.

So, the CCI forex indicator calculates and visually shows how fast prices are falling or rising.

The speed at which the price of a currency pair rises or falls can tell traders whether the price action will continue moving in that direction or not.

When the momentum wears off, you should expect the price action to pull back by reversing direction or by making a sideways movement.

And if the momentum is still strong, you should expect the price action to keep moving in the same direction.

The Commodity Channel Index (CCI) Settings

There are three variables for the CCI indicator that you can change.

They include the following…

  • Period/Length
  • Type of price
  • Levels

The period/length helps traders set the number of look-back periods.

It has a default value of 14 days.

However, you can change it depending on the forex CCI strategy that you are using.

For the type of price, most trading platforms provide a dropdown with options that you can select.

In TradingView for example, it’s provided as Source and you have many options to choose from.

Some of these options include open, low, close, high, etc.

The last indicator parameter is the levels.

By default, these are set to +100 and -100.

Note that these values can still be changed.

In the previous chart, we used the CCI indicator with a look-back of 20 periods.

This has been shown clearly on the chart.

If you apply this setting on a daily chart, this will be the past 20 days.

If the setting is applied on a 1-hour chart, this will be the past 20 hours.

How the Commodity Channel Index (CCI) Indicator Works

Now that you know the basics of the CCI indicator, how does it work?

This is how you should interpret this indicator…

  • When the CCI moves above +100, it signals the beginning of a new, strong uptrend.

This should send a buy signal to all the traders.

You can use other technical analysis methods and trending indicators to confirm the signals indicated by the CCI.

  • When the CCI move below -100, it signals the beginning of a new, strong downtrend.

This should send a sell signal to the traders.

When the CCI rises above -100, just close the position.

You can use other technical analysis methods and trending indicators to confirm the signals indicated by the CCI.

  • Find overbought levels above +100 and oversold levels below -100.

The CCI levels can be adjusted depending on the volatility of the market.

For example, if a currency is more volatile, you can use the levels of +200 and -200.

Note that the CCI indicator is not bound, meaning that it has no upside or downside limits.

Due to this, the interpretation of the overbought and oversold positions is subjective.

When the CCI is overbought, the price of the currency pair may continue to rise.

When the CCI is oversold, the price of the currency pair may continue to move lower.

This means that you should use the CCI indicator in conjunction with additional indicators or price analysis when you want to read overbought and oversold positions.

If the price action makes a new high or low that is not confirmed by the CCI, the divergence may be sending a signal of a price reversal.

Consider the chart given below…

trading-with-commodity-channel-index

The above chart shows the behavior of the CCI indicator in relation to the price action of a forex pair.

The black arrows on the price action and the indicator sections indicate the times during which the price action is moving upwards.

The red arrows on the price action and the indicator sections on the chart indicate the times during which the price action is moving downwards.

Each black arrow on the price action has a corresponding black arrow on the indicator section.

Similarly, each red arrow on the price action has a corresponding red arrow on the indicator section.

When the price moves upwards, the CCI indicator also move upwards.

When the CCI indicator moves above the +100 level, there is a corresponding strong bullish momentum in the price action.

This confirms the fact that a CCI of above +100 signals the presence of a strong bullish move in the market.

Again, from the chart, when the price action moves downwards, the CCI indicator also moves downwards.

When the CCI indicator moves below the -100 level, there is a corresponding strong bearish momentum in the price action.

This acts as a confirmation for the fact that a CCI of below -100 signals the presence of a strong bearish move in the market.

How to Calculate the Commodity Channel Index (CCI)

So far, we’ve discussed much about the CCI indicator.

It is now time for you to know how to calculate the value of this indicator.

This will help you get a complete view of the CCI indicator and understand how it plots the values.

The CCI is calculated by finding the difference between the mean price of the currency pair and the average of the means over the selected period of time.

The difference is then compared to the average distance over the time period.

When the averages of the differences are compared, the volatility of the currency pair is factored in the calculation.

The result is then multiplied by a constant to ensure that the values fall within the standard range of -/+100.

So, the CCI indicator uses the following formula to calculate the momentum…

CCI = [(Typical Price –20-Period SMA of the Typical Price) / (0.015 x Mean Deviation)]

Typical price = (High + Low + Close)/3

The 20-Period SMA of the Typical Price is the simple moving average for the typical price for the past 20 periods.

The 0.015 is a constant that is used to smooth the CCI values so that they can fall within the range of +100 and -100.

The Mean Deviation is calculated by subtracting the SMA value of the typical price from the typical price.

These values are added up and then divided by the total number of periods, which is normally 20.

So, it’s important for you to note that the CCI indicator uses a 20-period SMA.

You don’t have to worry even if the above calculations seem to be complicated to you.

What you must know is that the CCI uses a typical price and it measures it against a 20-period simple moving average value.

The obtained result is then divided by the constant 0.015 so that the values may fall between +100 and -100 and the mean deviation shows how far the price has deviated from its mean price.

In general, when the price has a strong momentum, expect a deviation from the mean price.

The price will keep on moving in that direction, whether rising or falling, provided it has momentum.

However, when the momentum slows, you should expect the price to revert to the mean.

Or, a correction in the most recent price trend may occur.

So, the CCI calculation simply measures how fast the prices are rising or falling, by moving within the fixed levels that have been mentioned.

Uses of the Commodity Channel Index (CCI) Indicator

There are three different ways to build a trading system using the CCI indicator.

Let’s discuss them…

Using CCI as a Trend Indicator

You can use the CCI trend indicator to signal the strength of a trend.

When a trend is showing a strong momentum, there are high chances that the price action will continue in the same direction, either rising or falling.

This means that you can trade in the same direction as the price.

If the price is rising and the trend shows a strong momentum, you can enter a long position by buying the currency pair.

If the price is falling and the trend is showing a strong momentum, you can enter a short position by selling the currency pair.

So, anytime that you need to know how strong the trend of a currency pair is, just look at what the CCI indicator says.

To make the CCI a more reliable trend indicator tool, it will be good for you to combine it with other trend indicators like moving averages.

This way, you can pick tops in a decline or bottoms in a rally.

It means that if you use the CCI as a trend indicator, you will be able to time your entries within a trend.

Consider the chart given below…

commodity-channel-index-indicator

In the above chart, we have combined the 20 and 50 moving averages with the CCI indicator on the same chart.

From the chart, you can tell that when the short term moving average is above the longer term moving average, it signals an uptrend.

You can confirm this from the price action itself.

From the CCI indicator, you can tell that the bullish momentum is renewed each time that the CCI indicator falls below -100.

When the CCI indicator rises above the -100 level, the bullish trend resumes, giving traders a nice opportunity to enter a long trade.

So, when you use the CCI indicator as a trend indicator, it can help you time your entries into a trend.

This will increase your chances of entering only trades where you have high chances of winning.

Using the the Commodity Channel Index (CCI) Indicator to Identify Divergence

Just like other technical indicators, you can use the CCI to spot divergences in the market.

You simply compare the price highs and lows to the CCI index values.

In general, higher highs or lower lows (or lower highs and higher lows) in price should be reflected by the CCI posting similar values.

When a discrepancy occurs when comparing the lows and the highs, you should expect the CCI divergence to show a price correction.

In most cases, the occurrence of a CCI divergence coincides with a slowdown in momentum.

And it’s a fact that when the momentum slows down, the price will stall or even reverse its direction.

Consider the chart given below…

commodity-channel-index

The above chart shows the formation of a CCI divergence.

The black line on the price shows that the price action creates a higher high.

This is an indication that the CCI indicator should plot a higher high at the same time.

However, this is not the case.

Instead, the CCI indicator plots a lower high.

This acts as an indication of a bearish divergence.

So, both the price and the CCI indicator should have plotted higher highs, but this has not happened.

But, what signal should the divergence send to the traders?

The divergence signals the Forex traders that momentum is fading and that the price action is about to fall or reverse direction.

You may also have instances where the price action plots a lower high, but the CCI index plots a lower low.

This will also create a divergence.

This divergence will be sending the signal that the price is beginning to rise again.

So, the currency pair will be resuming its bullish trend.

The CCI indicator can show a price divergence.

When the CCI indicator shows a divergence, see it as a warning that the price is about to go through a correction.

In some cases, the current trend may reverse when the CCI indicator shows a divergence.

So, as a forex trader, you must always pay attention when the CCI indicator shows a divergence.

Identifying Overbought and Oversold Levels using the CCI Indicator

You can use the CCI indicator to identify the overbought and the oversold areas in markets that are range bound.

This can be very helpful to you if you need to trade breakouts or if you need to trade within a range.

If you need to trade the overbought and oversold levels, the best approach will be for you to first identify a range or a sideways market.

After that, you can look for the highs and the lows that have been created by the price action.

Then, after the price has reached the upper range, look for the CCI indicator to show an exhausting momentum.

So, the CCI indicator should be falling after it has risen above +100.

Also, if the price reaches the lower range, look for the CCI indicator to show an exhausting momentum.

This means that the CCI indicator should be rising after falling below -100.

You can trade the range breakouts when you see the price breaking past the previous range high and there is a strong momentum.

In this case, the CCI indicator will be rising above +100.

To the downside, when the price breaks past the lower range, look for the CCI values to fall below -100.

Consider the chart given below…

the-commodity-channel-index

In the above chart, we began by plotting the horizontal range that was created by the markets.

This has been shown using two black lines running horizontally on the chart.

You can see this as a range bound market.

The application of the momentum can be used to check whether the momentum is sustainable for the price to either breakout from the range or reverse near one of the two levels.

The price made a bullish move, breaking out through the upper level of the range.

This has been shown by the black line marked as Bearish Divergence.

However, at the same time, the CCI indicator is showing a falling momentum, as it is falling below +100.

This has been shown by the black line on the indicator section marked as Exhaustion in Momentum.

There is also a divergence in the price.

When you combine all this information, it acts as a signal that the price will be returning back lower.

We can extend the price action further and see what happens.

The following chart shows this…

trading-with-the-commodity-index-channel

The above chart shows that the bearish move continued for a very long.

This came after the reversal of the bullish move.

This has been shown by the long red arrow running downwards.

The price action managed to break through the lower part of the range in a bearish direction.

This is the point where the price action managed to cross the black line, which is the lower level of the range.

At the same time, the CCI indicator moves downwards and manages to go below -100.

This acts as a signal that there is a strong bearish momentum in the market.

Due to this, the price continued to move lower.

This means that the initial divergence that occurred sent a right signal.

During the formation of the divergence, the price was rising, but the CCI indicator was moving downwards.

This indicates that the bullish trend has lost momentum, and it should reverse shortly.

This is exactly what happened as the price action reversed and made a very strong bearish move.

The price even managed to cross the lower level of the range.

So, you could have left your long position after the occurrence of the divergence.

You could have then entered a short position once the price reversed.

This could have prevented your profits from being wiped out from your trading account.

However, a trader who did not take the divergence as a signal that the bullish trend had exhausted its momentum most likely stayed in a long position.

Such a trader was caught on the wrong side of the market by the price reversal.

So, those are the three ways through which you can use a CCI forex trading strategy.

After considering how a market is moving, you can use a CCI trading system and look for how to make objective analysis of the markets.

Limitations of the Commodity Channel Index (CCI) Indicator

There is no technical indicator that should be used in isolation.

All indicators that work by mathematically transforming the price and volume data lag the price itself.

The reason is that there is so much data that is wrapped up in them.

The CCI indicator should be used in conjunction with other technical analysis or fundamental analysis tools.

The CCI indicator will only tell you that the price of an asset is out of line in relation to its historical average, but there could be legitimate fundamental reasons as to why this has happened.

In some cases, the valuations of currency pairs go through rapid and justifiable changes.

When you use the CCI as a price reversal indicator, it will interpret the change as an unsustainable move.

However, the prices of assets are not always mean reverting.

When many market participants catch on to the idea of the market moving in a particular direction, a trend will be formed.

That is why trend following is a great aspect of technical analysis.

With the CCI indicator, readings above +100 are interpreted as overbought.

However, these may be interpreted as an indication that an up-move has many buying behind it and it may run further.

Again, even though levels above +100 and below -100 may be interpreted as overbought and oversold respectively, they are not a reliable signal that the price will return back to more normative levels.

75% of CCI readings will fall within these two readings, which means that only 25% of the time will give off a potential trade signal.

Because of the uncertainty of whether these levels show breakouts or price extremes, it will be good to produce signals with other indicators.

Conclusion:

This is what you’ve learned in this article…

  • The Commodity Channel Index (CCI) indicator is an oscillator used by traders to identify cycles in commodity markets.
  • It belongs to the oscillator group of indicators, hence, it shows changes in momentum.
  • Momentum measures the chances of a price action continuing in the current trend, whether falling or rising.
  • The values for the CCI indicator range between +100 and -100.
  • Readings above +100 are considered overbought.
  • Readings below -100 are considered oversold.
  • To use the CCI indicator, three parameters are of great importance. These include the Period, Type of Price, and Levels.
  • The Period parameter denotes the length of look-back period to be considered.
  • The Type of Price parameter can take values such as High, Low, Open, Close, etc.
  • In most trading platforms, you will be provided with a dropdown to select these values from.
  • The Levels parameter specifies the levels for the CCI indicator, and they are set to +100 and -100 by default.
  • The CCI indicator can be used as a trend indicator, in which it will help traders determine the strength of a trend.
  • The indicator can also help traders to identify divergences in the market, which are an indication of a trend that is losing momentum.
  • You can also use this indicator to identify the overbought and oversold positions in the market.
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