Developed by Donald Lambert and featured in Commodities magazine in , the Commodity Channel Index CCI is a versatile indicator that can be used to identify a new trend or warn of extreme conditions. Lambert originally developed CCI to identify cyclical turns in commodities, but the indicator can be successfully applied to indices, ETFs, stocks, and other securities. In general, CCI measures the current price level relative to an 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. In this manner, CCI can be used to identify overbought and oversold levels.
The number of CCI periods is also used for the calculations of the simple moving average and Mean Deviation. Lambert set the constant at.
This percentage also depends on the look-back period. CCI measures the difference between a security's price change and its average price change. High positive readings indicate that prices are well above their average, which is a show of strength. Low negative readings indicate that prices are well below their average, which is a show of weakness. Plunges below reflect weak price action that can signal the start of a downtrend.
As a leading indicator , chartists can look for overbought or oversold conditions that may foreshadow a mean reversion.
Similarly, bullish and bearish divergences can be used to detect early momentum shifts and anticipate trend reversals. A move that exceeds this range shows unusual strength or weakness that can foreshadow an extended move.
Think of these levels as bullish or bearish filters. Technically, CCI favors the bulls when positive and the bears when negative. However, using a simple zero line crossovers can result in many whipsaws. There were four trend signals within a seven-month period.
Obviously, a day CCI is not suited for long-term signals. Chartists need to use weekly or monthly charts for long-term signals. The stock peaked on Jan and turned down. CCI moved below on January 8 days later to signal the start of an extended move. CCI does not catch the exact top or bottom, but it can help filter out insignificant moves and focus on the larger trend.
Some traders may have considered the stock overbought and the reward-to-risk ratio unfavorable at these levels. With the bullish signal in force, the focus would have been on bullish setups with a good reward-to-risk ratio. The subsequent surge above the flag trend line provided another bullish signal with CCI still in bull mode.
Identifying overbought and oversold levels can be tricky with the Commodity Channel Index CCI , or any other momentum oscillator for that matter. First, CCI is an unbound oscillator. Theoretically, there are no upside or downside limits. This makes an overbought or oversold assessment subjective. Second, securities can continue moving higher after an indicator becomes overbought. Likewise, securities can continue moving lower after an indicator becomes oversold. It is important to wait for these crosses to reduce whipsaws should the trend extend.
Such a system is not fool proof though. Notice how Google kept on moving higher even after CCI became overbought in mid-September and moved below Divergences signal a potential reversal point because directional momentum does not confirm price. A bullish divergence occurs when the underlying security makes a lower low and CCI forms a higher low, which shows less downside momentum.
A bearish divergence forms when the security records a higher high and CCI forms a lower high, which shows less upside momentum. Before getting too excited about divergences as great reversal indicators, note that divergences can be misleading in a strong trend.
A strong uptrend can show numerous bearish divergences before a top actually materializes. Conversely, bullish divergences often appear in extended downtrends. Confirmation holds the key to divergences. While divergences reflect a change in momentum that can foreshadow a trend reversal, chartists should set a confirmation point for CCI or the price chart.
A bearish divergence can be confirmed with a break below zero in CCI or a support break on the price chart. Conversely, a bullish divergence can be confirmed with a break above zero in CCI or a resistance break on the price chart. A longer timeframe, 40 versus 20, was used to reduce volatility. There are three sizable divergences over a seven-month period, which is actually quite a few for just seven months.
A support break on the price chart and CCI move into negative territory confirm this divergence a few days later. Second, a bullish divergence formed in early July as the stock moved to a lower low, but CCI formed a higher low. This divergence was confirmed with a CCI break into positive territory. Third, a bearish divergence formed in early September and this was confirmed when CCI dipped into negative territory.
Despite a CCI confirmation, price never broke support and the divergence did not result in a trend reversal. Not all divergences produce good signals. The indicator becomes overbought or oversold when it reaches a relative extreme. That extreme depends on the characteristics of the underlying security and the historical range for CCI. Volatile securities are likely to require greater extremes than docile securities. Trend changes can be identified when CCI crosses a specific threshold between zero and CCI is available as a SharpCharts indicator that can be placed above, below or behind the price plot of the underlying security.
Placing CCI directly behind the price makes it easy to compare indicator movements with price movements. The default setting is periods, but this can be adjusted to suit analysis needs. A shorter timeframe makes the indicator more sensitive. A longer timeframe makes it less sensitive. Two lines can be added by separating the numbers with a comma , Click here for a live example.
This scan reveals stocks that are in an uptrend with oversold CCI turning up. First, stocks must be above their day moving average to be in an overall uptrend.
Second, CCI must cross above to show the indicator rising from oversold levels. This scan reveals stocks that are in a downtrend with overbought CCI turning down. First, stocks must be below their day moving average to be in an overall downtrend. Murphy has a chapter devoted to momentum oscillators and their various uses. Murphy covers the pros and cons as well as some examples specific to the Commodity Channel Index.
Pring shows the basics of momentum indicators by covering divergences, crossovers, and other signals. There are two more chapters covering specific momentum indicators with plenty of examples.
Log In Sign Up Help. First, subtract the most recent period average of the typical price from each period's typical price. Second, take the absolute values of these numbers. Third, sum the absolute values. Fourth, divide by the total number of periodsMore...