All financial instruments, from commodities to stocks, from equities to indices, follow uptrends and downtrends in harmony. At such moments, investors and short-term traders prioritize identifying the direction of current and future trends and determining whether the financial assets being tracked are in overbought or oversold areas. Using the data obtained through the Commodity Channel Index (CCI), investors can easily adapt their investment strategies and manage their risk. You can find all the details about the definition of the Commodity Channel Index, how it works, how it is calculated, its advantages and disadvantages, and how it can be used in trading strategies in this comprehensive guide we have prepared for you.
What Is Commodity Channel Index (CCI)?
The Commodity Channel Index, a momentum-based oscillator, provides traders with insights into the persistence of price movements in financial markets, as well as information on overbought and oversold areas. With this technical indicator, traders can gain insight into the direction and strength of the trend.
How Does the Commodity Channel Index (CCI) Work?
Although many important factors are involved in the functioning of the Commodity Channel Index, the Typical Price, the Simple Moving Average of the Typical Price and the Mean Deviation, which are directly involved in the calculations, are at the forefront.
Typical Price is the average of the highest prices, lowest prices, and closing prices for predetermined time intervals. The simple moving average of the Typical Price helps investors determine the direction of the trend. Finally, Mean Deviation is the average of the absolute differences between the Typical Price and the simple moving average of the Typical Price for each period.
As a result of the calculations made with the data obtained, investors can access various data that can detect potential price movements and make more informed decisions with concrete and statistical data rather than predictions.
How Is the Commodity Channel Index (CCI) Calculated?
The Commodity Channel Index (CCI) is calculated by determining the difference between the mean price of a security and the average of the means over the period chosen. This difference is compared to the average difference over the period. Comparing the differences in the averages allows for the commodity’s volatility. The result is multiplied by a constant to ensure that most values fall within the standard range of +/- 100.
CCI = (AveP – SMA_of_AveP) / (0.015 * Mean Deviation)
Where: CCI = Commodity Channel Index AveP = Average Price = (High + Low + Close) / 3 (Also known as the Typical Price)
The 0.015 constant ensures that 70 to 80 percent of CCI values fall within the +100 to -100 range.
The path to be followed in the calculations can be listed as follows:
- The period to be calculated with CCI is determined. Although “20” is usually used to indicate this period range, shorter and longer time frames can also be used. Shorter time frames produce more volatile results, while longer time frames produce a smoother indicator. Let the specified time interval be denoted as “n”.
- Track the peak, low, and closing prices of n periods on a spreadsheet and compute the typical price.
- By the end of the n period, compute the moving average (MA) of the typical price by summing the last n typical prices and dividing by n.
- Calculate the average deviation by subtracting the MA from the typical price for the last n periods and sum the absolute values of the figures obtained (ignoring minus signs) and then divide by n.
- The latest typical price, average, MA, and average deviation are added to the formula to calculate the current CCI value.
How Do Traders Use the Commodity Channel Index (CCI)?
Since the Commodity Channel Index provides information about a financial instrument, it can find its place in various investment strategies. Especially short-term traders leave the period on the CCI as the most preferred 20 or go for lower time intervals. The most common elements that traders use in the results obtained on the CCI are the crossovers with zero line and overbought and oversold data.
Crosses above the zero line usually indicate that the trend is either about to change or is in a swing phase. In such cases, traders can use other technical indicators and macroeconomic conditions to determine which way the trend is more likely to turn and evaluate the relevant trading signals.
On the other hand, although it is appropriate to act more confidently by comparing past price movements, traders generally consider a reading above +100 to be overbought and a reading below -100 to be oversold. Based on these results, traders can modify their trading strategies and determine the optimal entry and exit points for their positions.
What Are The Advantages Of CCI?
- Overbought and Oversold Levels: Trading strategies integrated with the Commodity Channel Index can be used to identify overbought and oversold areas of financial assets. Usually, traders and investors check the numerical data on the indicator to measure the price level. Although there is no specific limit for each financial instrument, price movements above +100 are generally considered overbought, while values of -100 and below are considered oversold.
- Trend Identification: Since it is a technical indicator based on momentum and past price movements, the direction and strength of the trend can be revealed through the Commodity Channel Index. Through the CCI, which includes a line called the zero line, investors can also generate various trading signals by interpreting the intersections of this line as the trend changes.
- Adjustable Timeframes: The Commodity Channel Index, which is usually based on 20-day periods, can also be integrated into longer or shorter timeframes by adapting it according to investment strategies. Although short-term traders usually use 20-day CCI values, it is also common for long-term traders to use 50 and 100-day CCI values.
What Are The Disadvantages Of CCI?
- False Signals: To achieve meaningful results through the Commodity Channel Index, price movements need to occur with momentum. In low volatility environments, where price movements occur in a highly congested area, signals may be inaccurate and may result in loss of money to investors and short-term traders. Therefore, it is important to ensure that the financial environment is favorable for optimal results.
- Lagged Results: The Commodity Channel Index is an indicator based on past price movements and may reflect current data with a lag. The importance of using the CCI in conjunction with other indicators comes to the fore, especially considering that financial instruments can easily be affected by macroeconomic conditions and change trends.
- Lack of Fixed Levels: One of the most followed data by investors in the Commodity Channel Index is the identification of overbought and oversold zones. However, there is no fixed overbought or oversold level for each financial instrument. Therefore, investors should conduct asset-specific analysis and review historical data. Otherwise, trading may cause investors and short-term traders to lose money.
Who Developed The CCI?
The Commodity Channel Index, introduced for the analysis of cycles in commodity markets, was first mentioned in 1980 in Donald Lambert’s Commodity Channel Index: Tools for Trading Cyclical Trends. Lambert identified a cycle in commodity markets and conducted studies to identify possible trend reversals. The CCI, which emerged as a result of the studies carried out, was later used to identify potential overbought and oversold areas. Although it was created to detect price cycles in commodity markets, studies have shown that the Commodity Channel Index is effective in all areas of financial instruments such as stocks, ETFs, or cryptocurrencies.
How Is the Commodity Channel Index (CCI) Used In Technical Analysis?
When performing technical analysis, the Commodity Channel Index is used to identify divergences between price and indicator that indicate potential trend reversals, to monitor when and under what conditions past cycles may repeat, and to identify overbought and oversold areas of a financial asset.
What Trading Strategies Are Used With Commodity Channel Index (CCI)?
Divergences between price and indicator are one of the most important trading strategies for traders using the Commodity Channel Index. For example, scenarios where the price of a financial asset makes new lows but the Commodity Channel Index does not reach lower levels in line with price movements are referred to as bullish divergences and may indicate a price reversal.
Another strategy often preferred by traders is that when the levels expressed on the CCI reach levels such as -200 or -300 for a financial asset, it is usually referred to as an oversold area for that asset and a rise in the price is expected.
However, regardless of the results obtained on the indicator, research should always be done on other indicators and macroeconomic conditions and investors should manage their risk management in line with the results obtained, otherwise financial losses may be encountered.
When Do Traders Use the Commodity Channel Index (CCI) Indicator?
While the Commodity Channel Index can be used at any time by traders looking to make sense of trends and price movements, it is most commonly used during periods of market uncertainty and to identify new entry and exit points in stable markets.
- Periods of Market Uncertainty: Investors cannot make a definite judgment about whether the market will move up or down during these periods. The data obtained as a result of the determinations made through CCI can provide information about which direction the market is prone to, as well as making various judgments about the momentum of the trend.
- Identifying New Entry and Exit Points in Stable Markets: In a stable market, price movements may not always reach the expected levels. In such cases, CCI can provide traders with information on various issues such as overbought and oversold areas where the price enters extreme conditions, and allows them to adjust the entry and exit points for their positions accordingly.
How Effective Is Commodity Channel Index (CCI)?
The Commodity Channel Index (CCI) is considered to be one of the most effective oscillators as it provides traders with insights into several different issues, such as the trend pattern, potential overbought and oversold areas, and mismatches in the price movements of financial assets. On the other hand, several conditions must be met to make effective use of the CCI. Those who wish to integrate CCI into their trading strategies should be able to read charts and make various interpretations of current market conditions.
How Can Traders Use The CCI To Trade Different Markets?
First introduced by Donald Lamber to identify trend cycles in commodities, the Commodity Channel Index, like all other indicators, has been developed over time. The existence of certain trends and cycles in other areas of finance other than commodities, such as stocks and indices, has led technical analysts to use the CCI in other markets.
FAQ
How can I add the Commodity Channel Oscillator to the charts?
The Commodity Channel Oscillator is available in the indicators section of many trading platforms. If Commodity Channels is selected as an indicator to be displayed, it will automatically appear on the chart.
How can I know if the Commodity Channels are signaling correctly?
In case of doubt about the accuracy of the analysis results obtained through Commodity Channels, you can check whether the available data coincides across all instruments with the support of other technical indicators.
Can the Commodity Channel Oscillator be used on any timeframe?
Yes, the Commodity Channel can be used on all timeframes, depending on traders’ strategies.
Can the Commodity Channel Oscillator be applied to all financial instruments?
Yes, the Commodity Channel Oscillator can be used for all financial instruments.
Is the Commodity Channel Index suitable for traders of all levels?
Due to its complex formulas and the need for accurate interpretation of price movements, which sometimes produce false signals, the Commodity Channel Index is recommended for use by traders with prior knowledge of technical analysis.
Disclaimer
Eurotrader doesn’t represent that the material provided here is accurate, current, or complete, and therefore shouldn’t be relied upon as such. The information provided here, whether from a third party or not, isn’t to be considered as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any particular trading strategy. We advise any readers of this content to seek their advice.
