Introduction
The opportunities that the stock industry has to offer to those who are willing to take the plunge into it are many. But not many do so as the amount of hurdles that one has to experience initially to become a fully fledged trader can be quite hard to deal with.
A lot of people just tend to quit after some time without making any sort of head way after years of trading. Much of the time this comes from a lack of understanding of what the market is going through and even if they do know it they might be going through a hard time turning things in their favor.
Maybe they dont know or havent come across them but the amount of tools and resources available at their disposal should be more than enough to prevent that from happening. One such resource would be indicators and those are many like SMA, EMA, WMA and RSI and many more.
However we wont be looking at either of those here. What we’ll be looking at here instead is the CCI or the Commodity Channel Index.
What is CCI (Commodity Channel Index)?
So what even is the CCI indicator? Simply put it’s a momentum-based oscillator that’s used to help determine when an investment is reaching a certain condition within the market.
It was developed way back in the 1980s by Donald Lambert and ever since then it has only grown in popularity and become quite a common tool for all kind of investors.
The Purpose of CCI
As far as the purpose is concerned it’s made to find out overbought and oversold conditions for any stock and because of that it can evaluate the strength and direction of the price trend and gives traders a way to discern when to exit or enter trades, refrain or add more to present positions.
So it’s with this that traders may be provided various trading signals when the indicator is acting in a certain manner.
How is CCI Calculated?
Although any platform that supports the indicator will just calculate it for and you dont need to know the how, but if you’re curious about what goes into its calculations then read on, if not you could just skip ahead.
CCI Calculation Steps
The first step would be to find out how many periods the CCI will be covering, the most commonly used by traders is twenty. If you use fewer periods then that could result in more volatility so the more periods you use the smoother it will be basically.
So here let’s just take that default 20 or you can always adjust the calculation by using different numbers if you want.
Once you’ve found that out track the low, close and high for your period and calculate that typical price.
Then after those periods compute the MA or moving average of that typical price by totaling those last typical prices and then dividing it by the number of periods. So if you chose 20 for example then you would divide it by 20.
Following that you’ll need to calculate the mean deviation by subtracting that MA from that typical price for the previous 20 periods or so. Total the absolute values of such figures and then divide it by 20.
Insert the most recent typical price, the mean deviation and the MA within the formula to calculate current readings.
Repeat this process as every new period gets over.
Key Characteristics of CCI
The most standout characteristics based on what can be deduced from the formula above has to be the typical price, the mean deviation and the moving average. All are a must if you want to be able to calculate it.
Also despite it being an oscillator comparable to the RSI its values are not bound by range though values crossing -100 or +100 can convey something significant
How to Use CCI in Trading
Knowing how the CCI works is just the first step as you have to learn how to trade with it too or what it’s used for. Well to start with you can identify oversold and overbought conditions with it, determine divergences and confirm trends
Identifying Overbought and Oversold Conditions
Interestingly overbought and oversold conditions arent fixed because the indicator isn’t range bound. Because of that you’ll need to look at previous readings to have a sense of where things tend to reverse
For one stock you have get a reversal near -150 and +200 whereas another may reverse close to -350 and +325
One thing you can do is zoom out on that chart and see tons of price reversal points and what the CCI readings were at during them
CCI Divergences
Then like with many indicators within the landscape you get divergences too and those can be noted when the price moves in the opposite way the indicator is moving towards
If you see that the price is increasing but the CCI falling then this could be a weakness within the trend. While divergences aren’t always good trading signals since they last a pretty long time and dont always cause a price reversal they may still be good to at least warn traders that the possibility is still there and that’s what this indicator can be good for. At least this way you as a trader could tighten your stop loss levels or even hold off on executing new trades within the price trend direction
CCI and Trend Confirmation
One of the more obvious uses of the CCI has to be trend confirmation. But how will you discern those trends with it? That’s simple. If you see the CCI moving from near-zero or negative territory to over 100 that could indicate that the price is beginning a new uptrend.
Once this does happen traders could look for pullbacks in price which are then followed by rallies within both the CCI and the price to signal buying oportunities
If the exact opposite of what we’ve discussed happens with the CCI going below -100 then you get a potential downtrend
CCI Strategies for Different Trading Styles
Now that you know how the indicator is typically used in some actual trading you might want to know how you could tweak it to suit your style and within this landscape there are many styles
But the ones that are most often used tend to be day, swing and long-term trading which is why we’ll look at how the indicator can relate to them
Day Trading with CCI
For day trading since your focus is typically centered around short term profits you could adjust the timeframes to suit those needs i.e., make them shorter. Some strategies you could use would be scalping and momentum trading
Swing Trading with CCI
If you’re a swing trader now then your interests may primarily lie within the medium to long term gains. You could just use the default period length which is 20 or you could make it even longer. And because of that extra time you’re giving yourself you could benefit more from strategies that involve trend reversals or even breakouts
Long-Term Investing with CCI
Long term traders usually have their sights set on the long run and their positions can usually span anywhere from a month to a year. The first thing to do if you’re a long term trader is to set the time frames longer so that they reflect your goals.
As a long term trader you shouldnt let small or short term fluctuations affect you since you have to look at the bigger picture here. Look for breakouts and support and resistance levels and like the swing traders search for any kind of divergence or trend reversal
Advantages and Limitations of CCI
Knowing the pros and cons of any indicator is sure to land you in a favorable spot as you will have the means to circumvent its limitations and make the most out of what it gets right
Benefits of Using CCI
Starting off with those benefits it’s good for detecting overbought and oversold conditions, trends, divergences, can be versatile and suit multiple strategies or styles and is easy to adopt within automated trading systems
Limitations of CCI
Now with those benefits out of the way let’s turn our heads towards the cons. Firstly it’s a lagging indicator in that confirms price moves after the fact and this could cause delayed decision making as a result. Not only that but the potential for false signals is there too particularly inside range bound or sideways markets. And finally the information it provides is limited in that it wont tell you the duration of a trend
Conclusion
The CCI’s multifaceted nature has enabled it to be incorporated in various elements of stock trading but its not without its own set of drawbacks and the risk of false signals is still there so keep that in mind
What is the difference between CCI and RSI?
The CCI is not range bound whereas the RSI is and that’s the main difference.
What is the standard period for CCI?
20 appears to be the standard for it.
Can CCI be used for all asset classes?
No not really as it may not be that good for assets with little to no fluctuations in price. It’s a momentum indicator after all.
How can I avoid false signals with CCI?
Use it with other indicators for some additional confirmation.
Is CCI more suited for short-term or long-term trading?
It was made for long term trading so naturally it would be suited to that but that doesnt means that the short term is completely out of the equation as you could do some decent day trading with it if you know what you’re doing.