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Commodity Channel Index

Commodity Channel Index Commodity Channel Index

BY: NINAD RANADE

INTRODUCTION

The Commodity Channel Index (CCI) was developed by Donald Lambert and was first featured in the Commodities magazine in 1980. Lambert originally developed the CCI to identify cyclical turns in commodities, but the indicator can be successfully applied to forex, indices and stocks.

In general CCI measures the current price level relative to the average price level over a given period of time. CCI is relatively high when prices are far above their average. CCI is relatively low when prices are far below their average.

Commodity Channel Index (CCI) is a very versatile indicator that can be used to identify a new trend or warn of extreme conditions.

A robust trading system can be built using the Commodity Channel Index (CCI) indicator. CCI can also be used as a leading indicator which means that CCI can indicate a change of trend even before the price trend change actually takes place.


DEFINITIONS

To understand the Commodity Channel Index (CCI) a few terms need to be defined which will be used as we go into the details of this indicator:

Commodity Channel Index (CCI) is an indicator which measures the current price level relative to the average price level over a given period of time.

Simple Moving Average (SMA) is an indicator which shows the average value of a security’s price over a period of time and is calculated by adding the closing price of the security for a number of time periods (e.g. 12 days) and then dividing this total by the number of time periods.

Typical Price refers to the arithmetic average of the high (H), low (L) and closing prices (C) for a given period.

Mean Deviation is the average of absolute differences (differences expressed without plus or minus sign) between each value in a set of values, and the average of all values of that set. For example, the average of the set of values 1,2,3,4 and 5 is (15/3) = 3. The difference between this average (3) and the values in the set is 2,1,0,-1,-2 ; and the absolute difference being 2,1,0,1 and 2 . The average of those numbers is (6/5) =1.2, which is the mean deviation.


CALCULATION

The example shown below calculates the 20 period Commodity Channel Index (CCI). The number of CCI periods is also used for the calculation of Simple moving average and Mean Deviation.

CCI = (TP – 20 PERIOD SMA OF TP) / (0.015 * MEAN DEVIATION)

Where, SMA is Simple Moving Average, TP is Typical Price and Typical Price (TP) = (High + Low + Close) / 3, Constant = 0.015

Donald Lambert set the constant at 0.015 to ensure that approximately 70 to 80 percent of CCI values would fall between -100 and + 100. This percentage also depends on the look back period. A shorter CCI (10 period) would be more volatile with smaller percentage of values between +100 and -100. Conversely a higher CCI (40 period) will have a higher percentage of values between +100 and -100.


The following table illustrates the calculation of Commodity Channel Index (CCI) for daily values of EUR/USD pair.

 

The EUR/USD daily chart below illustrates how the Commodity Channel index (CCI) looks.


INTERPRETATION AND USES

Essentially the Commodity Channel Index (CCI) measures how far away the price is from the moving average and how fast it moved to get there. If the price is at the moving average, the CCI value will be zero. Hence, when CCI crosses above zero, it means that the price is also crossing above the moving average and is considered bullish. When CCI crosses below zero, it means that the price is crossing below the moving average and that is considered bearish.

The Commodity Channel Index (CCI) is also a momentum indicator since it measures how fast the price is moving away from or moving towards the moving average. Hence, price is considered to be in a strong upward momentum when CCI crosses +100 level. Conversely, price is considered to be in a strong downward momentum when CCI crosses below -100 level.

Commodity Channel Index is also very useful in identifying overbought and oversold levels. When CCI crosses over +200 it signifies that the price has run up extremely fast and the pair is overbought. When CCI crosses below -200 it signifies an extremely oversold condition. Prices are expected to correct from such an overbought/oversold condition. Overbought/oversold levels on CCI can be used to exit current positions or take up new positions to catch the corrective move.


COMMODITY CHANNEL INDEX (CCI) STRATEGIES

Commodity Channel Index (CCI) can be used as a standalone indicator or in conjunction with other indicators in order to build and robust trading system.

Simple Momentum System: Indicator: 20 period CCI

CCI is a momentum indicator and this system uses CCI to get into a security when it is showing momentum and to exit the trade when the momentum ceases.

Price is considered to be showing upward momentum when CCI rises above +100 and a downward momentum when CCI falls below -100.

Strategy Rules: This strategy takes a buy position when CCI first crosses above +100 level and exits the position when CCI falls back below +100. Sell position is taken when CCI falls below -100 and when CCI climbs back above -100 the position is squared off. The strategy uses only the CCI indicator to place trades. Hence, it is a very simple strategy which is easy to trade.


Below is an example of this strategy on EUR/USD pair:


The above EUR/USD chart shows that a buy position is taken at 1.31085, when CCI crosses the +100 level on 4/16/2013 at 10:00 hours. When CCI crosses below the +100 level on 4/16/2013 at 21:00 an exit signal is given at 1.31755, netting a profit of around 67 pips.

A sell signal is given on 4/17/2013 at 10:00 when CCI crosses below -100 at 1.31305 and an exit signal is given on 4/18/2013 at 06:00 hours when the price is at 1.30455 giving a profit of around 85 pips .


CCI WITH MOVING AVERAGE

Indicators: 20 period Commodity Channel index (CCI)

100 period Simple Moving Average (SMA)

This strategy takes buy or sell positions only in the direction of the trend. Trend is this case is identified by using the 100 period Simple Moving Average (SMA). If the price is above the SMA the trend is considers bullish. If the price is below the SMA the trend is bearish.

Once the trend is established, position is taken using the CCI only in the direction of the trend, when CCI crosses the zero line.

So if the trend is bullish as indicated by the price being above the Simple Moving Average (SMA), then a buy position is established whenever the CCI crosses above the zero line. Stops can be placed below the SMA and profit target can be two to three times the stop loss in pips. If the trend is bearish a sell position is established whenever CCI crosses below the zero line, with stops being placed above the SMA.


In the above chart it can be clearly seen that the price is above the 100 period SMA. Buy signal is shown by red arrows when the CCI crosses above the zero level.

This strategy is very popular and the advantage of this strategy is that we get to trade with the long term trend with very good probability of profits.


CCI Divergence system

Indicator: 20 period CCI

Divergence takes place when the price of an asset and an indicator move in opposite direction.

It has been discussed earlier that CCI is a leading indicator; it can show that a change in price trend is about to take place much before the change actually happens. This characteristic of CCI can be used to spot market tops and bottoms and to take full advantage of the price movement.

In this system a buy position is established when the price makes a lower low whereas the CCI makes a higher low on the charts.

A sell position is taken when price makes a higher high whereas CCI makes a lower high on the charts.


The USD/CAD daily chart below will illustrate this strategy:


The above chart shows that around 29th April 2013 both the USD/CAD and CCI made a low point. Thereafter around 8th May 2013 the USD/CAD made a lower low whereas the CCI was higher than its low on 29th April This divergence between the price and CCI gave an indication that the change in trend is about to take place . Buy trade is placed after the divergence is clearly defined. After this divergence set up the USD/CAD pair rallied more than 300 pips in 2 weeks.

On 17th May the USD/CAD pair and the CCI made a high and on 27th May the price continues to make higher highs whereas the CCI made a series of lower highs. This divergence set up gave us an early indication that the upward price trend is about to reverse. The price trend turns bearish and the price falls substantially over the next few days.


CONCLUSION

The Commodity Channel Index (CCI) is a very popular indicator which measures price momentum and can be used very effectively in a trading strategy. The indicator is very versatile, it can be used as a leading indicator, can also be used as a lagging indicator and the indicator can be used to spot extreme overbought and oversold levels.

Since this indicator was developed its popularity has increased. Many traders have devised their own strategies using the CCI indicator. There are forums dedicated to the CCI indicator. Commodity Channel Index (CCI) can be used in all market conditions and is suitable for various financial instruments. I hope this report on the Commodity Channel Index (CCI) is helpful in showing the significance of this popular indicator and in helping people to a better and successful trading.


April 2013


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