Detailed Guide to Trading with the CCI Indicator

The Commodity Channel Index (CCI) was developed in 1980 by Donald Lambert. This indicator is an oscillator used to identify periods when the market is overbought or oversold. Like most other oscillators, CCI is a linear oscillator but has its own unique features and advantages. What makes the CCI indicator special, and how can you use it most effectively in investment trading? Let’s explore this article to find out.

What is the CCI Indicator?

The CCI, or Commodity Channel Index, is an oscillating technical analysis tool developed by Donald Lambert in the 1980s. Despite its name, the indicator is effective not only in commodity markets but also in trading stocks, currencies, and other financial instruments.

Although the stock and currency markets are now more prevalent, the CCI indicator is named the Commodity Channel Index because trading initially started with commodity markets, such as grains, cotton, coffee, beans, etc. Following this, the first futures contracts for these commodities appeared. Agricultural producers needed futures contracts to hedge (insure) against risks in case of crop failures and natural disasters, and buyers of these securities needed to ensure they would receive the products at the agreed price from the seller in the future.

Over its existence, the commodity market has created many mathematical indicators that have become popular and included in the group known as classical technical indicators.

The Commodity Channel Index (CCI) was introduced in the October 1980 issue of Commodities magazine (now Futures magazine) by mathematician Donald Lambert. The CCI was designed to analyze daily price charts for commodity futures.

The main idea behind the CCI is that Donald Lambert used the concept of the market’s cyclical trends. Low volatility is interspersed with strong price fluctuations; high prices follow low prices and vice versa. Market movements repeat over time, although this repetition may not be exact.

If an investor can accurately identify market cycles, they can pinpoint optimal entry points when a downtrend ends, and an uptrend begins by using the CCI indicator.

In his articles, Lambert used 20 and 60-day periods. The first period was used for relatively short-term trading. The second period could be used in medium and long-term trading. Currently, investors also apply shorter CCI periods to trade assets more volatile than commodities.

Description of the CCI Indicator

Detailed Guide to Trading with the CCI Indicator

The CCI indicator uses the average of current and past price levels to measure price volatility in the market. It identifies overbought and oversold zones as well as ongoing trends in the market.

The CCI indicator is a moving average that oscillates around the zero line and ranges from -100 to +100. Based on this indicator, investors can identify upward/downward trends as follows:

  • CCI ranging from 0 to +100: the market is in an uptrend.
  • CCI ranging from 0 to -100: the market is in a downtrend.
  • When CCI > +100: the market is strongly bullish, creating an overbought zone => Price will adjust downward soon.
  • When CCI < -100: the market is strongly bearish, creating an oversold zone => Price will adjust upward soon.
  • When CCI fluctuates around the zero line, the market is moving sideways with little volatility.

Unlike the RSI or Stochastic Indicator, CCI is not bound by the +100 and -100 levels. However, statistically, 75% of the CCI indicator oscillates within the range of -100 to +100, and 25% lies outside this range. The Commodity Channel Index line can drop to -200 and -300, indicating a strong downtrend and an oversold market condition.

CCI Calculation Formula

Similar to most oscillators, the CCI indicator was developed to identify overbought and oversold levels. CCI is determined by measuring the ratio between the current price and the moving average (MA), meaning the normal deviation of the current price level from the average price.

The formula for calculating the CCI is as follows:

CCI=(AP−MA)MD×10.015CCI=MD(AP−MA)​×0.0151​

Where:

  • AP (Average Price) is the average of the three price levels in a session: AP=Close Price+High Price+Low Price3AP=3Close Price+High Price+Low Price​
  • MA (Moving Average) is the moving average calculated based on the average of the closing prices over a given number of periods. Using MA eliminates random deviations to obtain a clearer trend
  • MD (Mean Deviation) is the standard deviation of the MA
  • 015 is known as the “Lambert constant,” used to adjust the indicator values to lie within the range of -100 to +100.

Significance of the CCI Indicator

The CCI measures the difference between the price changes of an asset and the average price change. The significance of the CCI is reflected through divergence, trend, and overbought and oversold levels. More experienced investors can apply the CCI to interpret trend strength and the probability of a major trend reversal.

Overbought/Oversold Signals

Overbought and oversold are the basic oscillating signals of the CCI indicator.

  • When the CCI line crosses above +100 from below, the market is strongly bullish, creating an overbought zone => Price will adjust downward soon.
  • When the indicator line falls below -100, it indicates the market is strongly bearish, creating an oversold zone => Price will adjust upward soon.

Detailed Guide to Trading with the CCI Indicator

Convergence/Divergence Signals

Divergence is considered one of the strongest oscillating signals. Clear divergence and convergence (negative divergence) are not formed as frequently as the indicator signals entering the overbought and oversold zones; hence, divergence provides more reliable signals. Convergence and divergence can be identified by drawing straight lines through two or more local extremes on the price chart and the corresponding local extremes of the indicator. When the trend line on the price chart and the trend line on the indicator move in opposite directions, it is highly likely that the trend will change.

Detailed Guide to Trading with the CCI Indicator 2

Trend Indicator

The CCI trend indicator can be used to signal the strength of a trend. When a trend shows strong momentum, it is likely that prices will continue to rise or fall.

  • CCI ranging from 0 to +100: The market is in an uptrend, and the further it moves from zero, the stronger the uptrend.
  • CCI ranging from 0 to -100: The market is in a downtrend, and the further it moves from zero, the deeper the downtrend.

Trading with the CCI Indicator

Trend Following Trading

Based on overbought/oversold signals:

  • When the CCI indicator crosses above +100 from below, then reverses and crosses below +100, it signals a Sell.
  • When the indicator line falls below -100 and then crosses above -100, it signals a Buy.

Detailed Guide to Trading with the CCI Indicator 3

It is important to note that such signals appear quite frequently, and the probability of false signals is relatively high. Investors should use additional indicators or increase the normal oscillation range to filter out false signals. Overbought/oversold levels can be shifted to +150/-150 or +200/-200.

Divergence Signals

  • In a downtrend, when a convergence signal between CCI and price appears, indicating the market is about to reverse from down to up, it signals a Buy.
  • In an uptrend, when a divergence signal between CCI and price appears, indicating the market is about to reverse from up to down, it signals a Sell.

Detailed Guide to Trading with the CCI Indicator 4

Combining with Other Indicators

As with most technical indicators, CCI should be used in conjunction with other forms of technical analysis such as MACD and RSI.

Buy Signal

  • The MACD line has crossed above the signal line, indicating an uptrend.
  • The RSI has risen above the oversold level (below 30), signaling a potential upward reversal.
  • The CCI has risen above the oversold level (below -100), indicating a potential upward reversal.

Sell Signal

  • The MACD line has crossed below the signal line, indicating a downtrend.
  • The RSI has moved below the overbought level (above 70), signaling a potential downward reversal.
  • The CCI has moved below the overbought level (above 100), indicating a potential downward reversal.

Comparing CCI with RSI

Both the Relative Strength Index (RSI) and the Commodity Channel Index (CCI) are momentum oscillators used to identify overbought/oversold levels and show divergence. The CCI has strong and weak overbought and oversold levels, while the RSI has market regions called overbought and oversold.

RSI calculates the average price increase and decrease over a specific period. Typically, the default period is set to 14 periods. RSI values are plotted on a scale from 0 to 100. Unlike RSI, CCI is usually calculated over a 20-period span and does not have specific range limits.

The CCI frequently displays overbought/oversold zones more often than RSI. This is because CCI is more sensitive to price changes and can be used to identify overbought or oversold conditions earlier