Commodity Channel Index (CCI) Indicator – Trading Strategy

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How Traders Use CCI (Commodity Channel Index) to Trade Stock Trends

How Do Traders Use CCI (Commodity Channel Index) to Trade Stock Trends?

The CCI, or Commodity Channel Index, was developed by Donald Lambert, a technical analyst who originally published the indicator in Commodities magazine (now Futures) in 1980.   Despite its name, the CCI can be used in any market and is not just for commodities. 

CCI is calculated with the following formula:

(Typical Price – Simple Moving Average) / (0.015 x Mean Deviation) 

The CCI was originally developed to spot long-term trend changes but has been adapted by traders for use on all markets or timeframes.   Trading with multiple timeframes provides more buy or sell signals for active traders. Traders often use the CCI on the longer-term chart to establish the dominant trend and on the shorter-term chart to isolate pullbacks and generate trade signals.

Key Takeaways

  • The CCI is a market indicator used to track market movements that may indicate buying or selling. 
  • The CCI compares current price to average price over a specific time period. 
  • Different strategies can use the CCI in different ways, including using it across multiple timeframes to establish dominant trends, pullbacks, or entry points into that trend. 
  • Some trading strategies based on CCI can produce multiple false signals or losing trades when conditions turn choppy. 

The strategies and indicators are not without pitfalls, and adjusting strategy criteria and the indicator period may provide better performance. Although all systems are susceptible to losing trades, implementing a stop-loss strategy can help cap risk, and testing the CCI strategy for profitability on your market and timeframe is a worthy first step before initiating trades.

Understanding How Traders Use CCI (Commodity Channel Index) to Trade Stock Trends

CCI Indicator

The CCI compares the current price to an average price over a period of time. The indicator fluctuates above or below zero, moving into positive or negative territory. While most values, approximately 75%, fall between -100 and +100, about 25% of the values fall outside this range, indicating a lot of weakness or strength in the price movement. 

Figure 1. Stock Chart with CCI Indicator

The chart above uses 30 periods in the CCI calculation; since the chart is a monthly chart, each new calculation is based on the most recent 30 months. CCIs of 20 and 40 periods are also common. 

A period refers to the number of price bars the indicator will include in its calculation. The price bars can be one-minute, five-minute, daily, weekly, monthly, or any timeframe you have accessible on your charts. 

The longer the period chosen (the more bars in the calculation), the less often the indicator will move outside -100 or +100. Short-term traders prefer a shorter period (fewer price bars in the calculation) since it provides more signals, while longer-term traders and investors prefer a longer period such as 30 or 40. Using a daily or weekly chart is recommended for long-term traders, while short-term traders can apply the indicator to an hourly chart or even a one-minute chart. 

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Indicator calculations are performed automatically by charting software or a trading platform; you’re only required to input the number of periods you wish to use and choose a timeframe for your chart (i.e., 4-hour, daily, weekly). Stockcharts.com, Freestockcharts.com, and trading platforms such as Thinkorswim and MetaTrader all provide the CCI indicator.

When the CCI is above +100, this means the price is well above the average price as measured by the indicator. When the indicator is below -100, the price is well below the average price. 

CCI Basic Strategy

A basic CCI strategy is used to track the CCI for movement above +100, which generates buy signals, and movements below -100, which generates sell or short trade signals.   Investors may only want to take the buy signals, exit when the sell signals occur, and then re-invest when the buy signal occurs again.

Figure 2. ETF Chart with CCI Basic Trade Signals

The weekly chart above generated a sell signal in 2020 when the CCI dipped below -100. This would have told longer-term traders that a potential downtrend was underway. More active traders could have also used this as a short-sale signal. This chart demonstrates how in early 2020 a buy signal was triggered, and the long position stays open until the CCI moves below -100. 

Multiple Timeframe CCI Strategy

The CCI can also be used on multiple timeframes. A long-term chart is used to establish the dominant trend, while a short-term chart establishing pullbacks and entry points into that trend. More active traders commonly use a multiple timeframe strategy, and one can even be used for day trading, as the “long term” and “short term” is relative to how long a trader wants their positions to last.

When the CCI moves above +100 on your longer-term chart, this indicates an upward trend, and you only watch for buy signals on the shorter-term chart. The trend is considered up until the longer-term CCI dips below -100.

Figure 2 shows a weekly uptrend since early 2020.   If this is your longer-term chart, you will only take buy signals on the shorter-term chart.

When using a daily chart as the shorter timeframe, traders often buy when the CCI dips below -100 and then rallies back above -100. It would then be prudent to exit the trade once the CCI moves above +100 and then drops back below +100. Alternatively, if the trend on the longer-term CCI turns down, that indicates a sell signal to exit all long positions.

Figure 3. Buy Signals and Exits in Longer-term Uptrend

Figure 3 shows three buy signals on the daily chart and two sell signals. No short trades are initiated, since the CCI on the long-term chart shows an uptrend. 

When the CCI is below -100 on the longer-term chart, only take short sale signals on the shorter-term chart. The downtrend is in effect until the longer-term CCI rallies above +100. The chart indicates that you should take a short trade when the CCI rallies above +100 and then drops back below +100 on the shorter-term chart. Traders would then exit the short trade once the CCI moves below -100 and then rallies back above -100. Alternatively, if the trend on the longer-term CCI turns up, exit all short positions.

Alterations and Pitfalls of CCI Strategies

You can use CCI to adjust the strategy rules to make the strategy more stringent or lenient. For example, when using multiple timeframes, make the strategy more stringent by only taking long positions on the shorter timeframe when the longer-term CCI is above +100. This reduces the number of signals but ensures the overall trend is strong.

Entry and exit rules on the shorter timeframe can also be adjusted. For example, if the longer-term trend is up, you may allow the CCI on the shorter-term chart to dip below -100 and then rally back above zero (instead of -100) before buying. This will likely result in a paying a higher price but offers more assurance that the short-term pullback is over and the longer-term trend is resuming.

With the exit, you may want to allow the price to rally above +100 and then dip below zero ​(instead of +100) before closing the long position. While this could mean holding through some small pullbacks, it may increase profits during a very strong trend.

The figures above use a weekly long-term and daily short-term chart. Other combinations can be used to suit your needs, such as a daily and hourly chart or a 15-minute and one-minute chart. If you’re getting too many or too few trade signals, adjust the period of the CCI to see if this corrects the issue. 

Unfortunately, the strategy is likely to produce multiple false signals or losing trades when conditions turn choppy. It is quite possible that the CCI may fluctuate across a signal level, resulting in losses or unclear short-term direction. In such cases, trust the first signal as long as the longer-term chart confirms your entry direction.

The strategy does not include a stop-loss, although it is recommended to have a built-in cap on risk to a certain extent. When buying, a stop-loss can be placed below the recent swing low; when shorting, a stop-loss can be placed above the recent swing high.

Commodity Channel Index (CCI)

Predictions and Analysis

Commodity Channel Index (CCI)

The Commodity Channel Index (CCI) is a momentum oscillator used in technical analysis that measures an instrument’s variations from its statistical mean. The CCI is a very well-known and widely-used indicator that has gained a level of popularity in no small part due to its versatility. It is a fully unbounded oscillator and has no lower or upper limit. The CCI is often used to find reversals as well as divergences. Originally, the indicator was designed to be used for identifying trends in commodities, however, it is now used on a wide range of financial instruments.

Read more about the Commodity Channel Index.

What Is The Commodity Channel Index (CCI) + 2 Trading Strategies

The Commodity Channel Index indicator was designed by Donald Lambert and fits into the category of being a momentum indicator for those involved in technical analysis. Due to the lines on the indicator, it is often used as an oversold and overbought indicator.

That can often be a flawed use of the CCI considering it is a momentum oscillator that is designed to show momentum in the market. It stands to reason that if a market has enough momentum to drive the CCI into overbought territory, that indicates the market is strong.

Some will argue that an overbought market is in line to reverse at least temporarily. There’s a saying that a market can remain overbought longer than you can remain solvent.

I agree. Many traders loving trading reversals in the market and use the CCI to justify their opinion that the market “is due for a pullback“.

The designer, Donald Lambert, actually looked at oversold or overbought conditions as a reason to trade in that direction with the theory that strength in the market is a good thing.

If the CCI goes above the + 100 line, that’s a signal to establish a long position. When the CCI drops below the + 100 line, the long position is closed out. The same techniques apply to short positions at the -100 line. You can modify the CCI to set your own parameters.

You just have to rely on a trading plan that has specific criteria for entering the market so you are not depending on a lagging indicator for the basis of your trading.

How To Calculate CCI

The good thing is that most charting platforms have the CCI built into their indicator selection. It never hurts to have an understanding of how the CCI is calculated to help you fully understand the nuances of this trading indicator.

CCI = (Typical Price – 20 Period SMA of Typical price) / (.015 x Mean Deviation)

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

Keep in mind that some traders may alter how the typical price is calculated but for now, just focus on the accepted calculation.

Why is 0.15 used? Here is how Lambert explained that figure:

The use of a .015 constant in the CCI formula scales the resulting CCI value so 70% to 80% of the random fluctuations fall within a +100% to -100% channel

What that means that if the Commodity Channel Index heads into the oversold or overbought condition, that is outside the normal fluctuations of a market. That indicates strength (or weakness) and is a good time to either place a trade or exit one you are currently in.

5 THINGS YOU NEED TO KNOW ABOUT CCI INDICATOR

  1. CCI is an indicator that is classified as an oscillator. Oscillators tend to have levels that indicates overbought or oversold.
  2. If the price of a currency pair is overbought then it would read over +100. What this means is the the currency pair’s price has risen with momentum and has deviated from the normal fluctuations of the that market..
  3. The CCI oscillates below and above zero level.
  4. When the Commodity channel index reads -100 then the market or price at the time is considered oversold. What this means is the the currency pair’s price has fallen with momentum and has deviated from the normal fluctuations of the that market..
  5. The CCI is a lagging indicator

To summarize so far: the CCI is an indicator that measures how far apart the price is moving away from the average prices. It the CCI reads overbought or oversold then this tells you that the price has exceeded the normal price movement(the standard deviation) away from the average.

PROBLEMS WITH USING CCI TO TRADE

If you were to follow the trading signals generated by CCI, without any other technical analysis or price action study, then these are the problems you will encounter as shown by the chart below:

Commodity Channel Index Trade Examples

Notice on the chart above that(starting from left):

  1. Buy signal was a false buy signal
  2. Second buy signal by the CCI after it bounced back up from the -100 line was ok and would have resulted in profits.
  3. Third sell signal given by CCI was false as it was too early
  4. The 4th trading signal given by the CCI was false as you can see that the trend was still up but yet the commodity channel index indicator gave a sell signal
  5. The 5th sell signal was good and would have been a profitable trade.
  6. The 6th buy signal after bouncing up from the -100 CCI line would have been profitable
  7. The 7th signal was a sell signal generated by CCI and notice that this signal was given after there was already a downward move…thus the statement that because CCI is a lagging indicator, it gives you the signal to trade ” at least one candle after the optimal entry point in price

Why Use The CCI If It Has These Issues?

Trading the CCI all alone by itself will do you no good but having said that, here’s a few reasons for keeping the CCI indicator in your trading tool chest.

  • CCI can be useful as a decision-supporting tool
  • CCI can be used to identify divergence (CCI Divergence) on the chart
  • Help identify overbought or oversold conditions
  • It’s a great tool for swing trading and entry triggers

So can we tie all the good things about the CCI into something that we can actually trade as a Forex strategy?

Two Of The Best Ways to Use The CCI As Part Of A Trading Strategy

  1. Trading CCI with Moving Averages
  2. Trading CCI with support and resistance levels

#1: HOW TO TRADE CCI WITH MOVING AVERAGES

The logic for this is very simple: moving averages show us the trend but CCI is an oscillator that just shows us whether the market is oversold or overbought. The CCI cannot tell you about the trend but can tell you about the strength of the trend.

But here’s the problem: you are combining two lagging Forex indicators which will not give you optimum entries.

So to help put the odds in our favor, we are going to look to price action trading to help lessen the lagging issue with all indicators.

Here’s an example:

  • We have two moving averages, 9 exponential moving average and 18 exponential moving average and they have just crossed over to the downside: which means there’s a great chance that it’s now a downtrend.
  • We do not enter a sell order immediately at the crossover of the moving averages.
  • We wait until price rallies back up to the moving averages, and then we look at the CCI to see if it is above the 100 or just crossed below it.
  • If that’s the case, then we know we have a sell signal to sell right there. Confirm these trading signals with bearish reversal candlestick patterns as shown on the chart below:

How To Trade CCI With Moving Averages

#2: HOW TO TRADE CCI WITH SUPPORT AND RESISTANCE LEVELS

You first should fully understand how to draw support and resistance levels on your chart. These will give you an objective location to begin looking for a trading setup

  • You see price heading down to a support level and then you look at the CCI indicator to see if the market is in an oversold condition.
  • If so there’s a likely chance that the market may bounce up from the support level and go up so look for a buy opportunity.

For a buy trade setup, the opposite is true.

  • if price is heading up to a resistance level, then look at the Commodity Chanel Index to see if the market is in an overbought condition.
  • If so, there’s a great chance that the market may hit the resistance level and head back down.

It is also a good idea to confirm these with bearish reversal candlestick patterns to go short when trading the bounce of a resistance level like shown on the chart below:

Commodity Channel Index Trading With Support And Resistance Levels

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