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Academy > Technical Analysis > Commodity Channel Index: How to Use The Oscillating Indicator >

Commodity Channel Index: How to Use The Oscillating Indicator

2021-02-24 01:47:46

commodity-channel-index

What is the Commodity Channel Index (CCI)?

The Commodity Channel Index — or CCI, for short — is a momentum-based oscillating technical indicator developed by Donald Lamber to primarily assess whether the price of a commodity is overbought or oversold. It is also used when evaluating the strength of a trend to enter, exit, or ignore a trade, or adjust an existing trade.

Despite its name, the Commodity Channel Index is not only an indicator for commodities. It may also be applied to assets, stocks, Bitcoin and other cryptocurrencies, etc.

In the simplest terms, the Commodity Channel Index measures the difference between a commodity’s current price and its historical price average. Measurements above zero indicate that the price of an asset is above its historical average. Likewise, a CCI measurement below zero means that the price is trading below its historical average.

cci on bitcoin futures

An example of the CCI showing periods of overbought and oversold action for BTC on the CME Bitcoin Futures chart. Source: TradingView

In slightly more advanced terms, the CCI is used to identify divergences. Just like with many other indicators — such as the Relative Strength Index (RSI) — when the indicator conflicts with current price action, this may signify that the current trend is weakening and may reverse.

For example, if the price of BTC is trending upwards, but the CCI is trending downwards, this may be a bearish divergence. Conversely, if the price of BTC is trending downwards and the CCI is trending upwards, this may signify a bullish divergence.

However, divergences on the CCI are not considered strong signals and don’t necessarily indicate that a price reversal will occur. Instead, many traders use divergences as warnings that a reversal may be in the cards, so it may be in their interest to tighten stop losses or start taking profits on a long or short position.

btc increased as CCI decreased

The price of BTC on the CME Bitcoin Futures chart increased as the CCI decreased, creating a bearish divergence that ultimately resulted in a harsh sell-off. Source: TradingView

Additionally, the Commodity Channel Index may also be used to identify the start of a fresh uptrend or downtrend.

For example, if the CCI surges from levels below zero to those above 100, a new uptrend may be underway. Conversely, if the CCI goes from levels above zero to below -100, a fresh downtrend may be underway.

In both of these scenarios, traders may start looking for long or short opportunities.

use CCI to long Bitcoin

The price of BTC on the CME Bitcoin Futures chart surged from deeply negative territory to overbought territory, creating an opportunity to enter a long trade on the subsequent pullback. Source: TradingView

How is the CCI calculated?

The Commodity Channel Index bears some similarities to the Stochastic Oscillator, but the calculations for both are not the same. The most pertinent difference between the two oscillating indicators is that the Stochastic Oscillator is bound between zero and 100. The CCI, on the other hand, has no upper or lower bound. As such, the signals provided by the two are quite different.

Despite this difference, the CCI’s calculations are not as complicated as some other technical indicators’.

Firstly, the technical analyst must choose the number of periods the CCI should analyze — with 20 being a common choice. As a general rule, fewer periods equate to an indicator with more extreme volatility, whereas more extended periods lead to a smoother and less volatile indicator.

Secondly, the technical analyst tracks the high, low, and close for their chosen period — for this example, let’s simply use 20. Next, the moving average is found by adding the last 20 prices and dividing by 20.

After finding the moving average, the mean deviation is calculated by subtracting the MA from the last 20 periods’ typical price. Afterward, the absolute values are added together and then divided by 20.

Finally, the calculations are input into the following formula to compute the current CCI:

CCI = (Typical Price – MA) / (.015 x Mean Deviation)

Conclusion

The Commodity Channel Index is a useful technical indicator for identifying when an asset may be overbought or oversold. It may also be used to identify bullish and bearish divergences to predict when a trend may be running out of steam and eyeing a reversal.

Still, the CCI, like all technical indicators, is not without its flaws. Though it is primarily used to identify overbought and oversold conditions, the indicator is unbound — meaning there are no minimum or maximum values. As such, historical overbought and oversold readings are even less indicative of future performance than some other indicators.

Another issue with the CCI is that it is a lagging indicator. Like all such indicators, it does a relatively poor job of identifying exact tops or bottoms — since it tends to be more reactionary than proactive. As such, it is better for timing long or short entries on corrections or bounces since the trend has usually already gone underway.

The lagging nature of the Commodity Channel Index makes it vulnerable to whipsaws — when an indicator gives a signal but the price does not complete a follow-through in the direction of the expected move. This results in a losing trade. Because of this, the CCI — like all technical indicators — is best used in conjunction with other technical indicators and a well-defined and careful trading strategy.


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