Commodity Channel Index (CCI)

The Commodity Channel Index (CCI) is a technical indicator that assesses the current price level in relation to an average price level over a specified time frame. Developed by Donald Lambert, it was initially intended to pinpoint cyclical shifts in commodities. The CCI is classified as a momentum oscillator, which means it helps identify overbought and oversold conditions. The core premise of the CCI indicator is that commodities exhibit cyclical behavior, with peaks and troughs occurring at regular intervals. The CCI signals when one of these cyclical reversals is about to happen. Although Lambert originally applied the CCI to commodity trading, it is now utilized across various asset classes.

The CCI evaluates the current price level against an average price level over a designated period. The CCI oscillates above and below zero, indicating a relatively high value when prices are significantly above their average and a relatively low value when prices are considerably below their average. This method allows the CCI to identify overbought and oversold conditions. The proportion of CCI values that lie between +100 and -100 is influenced by the number of periods used; a shorter CCI tends to be more volatile, resulting in a smaller percentage of values within this range. Conversely, using more periods to calculate the CCI increases the percentage of values between +100 and -100. Lambert's trading guidelines for the CCI emphasized movements above +100 and below -100 to generate buy and sell signals. Since approximately 70 to 80 percent of CCI values fall between +100 and -100, buy or sell signals are generated only 20 to 30 percent of the time.

Buy Signal

A buy signal is triggered when the CCI rises above +100, indicating that the price is entering a strong uptrend. The position should be closed when the CCI falls back below +100.

Sell Signal

A sell signal occurs when the CCI drops below -100, suggesting that the price is in a strong downtrend. The position should be closed when the CCI rises back above -100.

The CCI is a flexible indicator that can be applied in various ways.

Overbought and Oversold Levels

The CCI is utilized to identify overbought and oversold conditions. An asset is deemed oversold when the CCI falls below -100, and a buy signal may be generated when the CCI subsequently rises above -100. Conversely, an asset is considered overbought when the CCI exceeds +100, with a sell signal potentially occurring when the CCI drops back below +100.

CCI Divergence

Divergences between the CCI and actual price movements can enhance the strength of signals. A positive divergence below -100 can strengthen the signal for a move back above -100, while a negative divergence above +100 can bolster the signal for a move back below +100.

CCI Trend Line Breaks

Trend line breaks can also be used to generate signals. Trend lines can be drawn by connecting peaks and troughs. A move above -100 from oversold levels, along with a trend line breakout, is considered bullish. Conversely, a decline below +100 from overbought levels, accompanied by a trend line break, is viewed as bearish. Traders employ the CCI to identify price reversals, extremes, and trend strength. As with most technical indicators, the CCI should be used alongside other forms of technical analysis.

Calculating the CCI involves several steps, outlined in the correct sequence below.

First, compute the typical price using the high, low, and close for the interval. This is the simple arithmetic average of these three values, represented by the formula:

TP = (High + Low + Close) / 3

Where TP is the typical price, High is the highest price for this interval, Low is the lowest price for this interval, and Close is the closing price for this interval.

Next, calculate a simple moving average of the typical price for the specified number of periods:

TPAVG = (TP1 + TP2 +... + TPn) / n

Here, TPAVG is the moving average of the typical price, TP is the typical price for the nth interval, and n is the number of intervals for the average.

The next step involves calculating the mean deviation, using the formula:

MD = (|TP1 - TPAVG1| +... + |TPn - TPAVGn |) / n

In this formula, MD represents the mean deviation for this interval, TPn is the typical price for the nth interval, TPAVGn is the moving average of the typical price for the nth interval, and n is the number of intervals. The absolute value is denoted by the symbol | |, meaning negative differences are treated as positive values.

Finally, the computation for the CCI value is as follows:

CCI = (TPt - TPAVGt) / (.015 * MDT)

In this equation, CCI is the Commodity Channel Index for the current period, TPt is the typical price for the current period, TPAVGt is the moving average of the typical price, .015 is a constant, and MDT is the mean deviation for this period. Lambert set the constant at .015 to ensure that approximately 70 to 80 percent of CCI values would fall between -100 and +100.