Hello friends. Previously, I talked about the importance of technical indicators as a part of technical analysis. Technical indicators are the most important tools we need when trading in financial markets. Today, we will discuss another technical indicator, the Commodity Channel Index (CCI) Indicator.
What is the Commodity Channel Index (CCI) Indicator?
The Commodity Channel Index (CCI) is a momentum indicator
that measures how far a price of an asset deviates from its average price. The
CCI indicator was created by Donald R. Lambert in the early 1980s. Lambert
developed this indicator to provide commodity market traders with an analytical
tool to support their trading decisions. The CCI indicator can be used not only
in commodity markets but also in other financial markets. It is commonly used
to identify overbought and oversold conditions in markets such as stocks,
commodities, and other financial instruments. Aside from this, the CCI
indicator can be employed to determine trends, identify overbought and oversold
levels, and establish support and resistance levels. This indicator tracks
price movements and deviations by using the moving average of the typical
price.
How the Commodity Channel Index Formula Works
When traders study the Commodity Channel Index, they usually start by looking at the Commodity Channel Index formula. The Commodity Channel Index formula helps them understand how the indicator measures the distance between the price and its average value. This formula uses the typical price, the moving average of that price, and the mean deviation.
Many beginners think the Commodity Channel Index formula is hard, but once they break it into smaller steps, it becomes much easier. First they take the typical price, then they compare it with the moving average, and after that they divide the result by the mean deviation. Because of this structure, the indicator shows when the price is far above or far below its usual level. Traders like the CCI because it reacts fast to market changes, and knowing the Commodity Channel Index formula helps them understand why the indicator moves the way it does. When they see sharp moves up or down, they can tell whether the price is entering an active area or leaving one.
Calculation of Commodity Channel Index (CCI)
The standard setting for CCI is 20, which means CCI measures
price changes over a 20-day period. However, different settings can be used.
For instance, a 14-day CCI might be more responsive, while a 50-day CCI could
be less sensitive. The optimal setting for CCI depends on the trader's
preferences and trading style. The values of the CCI indicator range from 0 to
100. Values above +100 are considered overbought, while values below -100 are
considered oversold. The calculation formula for the Commodity Channel Index
(CCI) is as follows:
CCI = (TP - SMA) / (0.015 * MAD)
Here are the terms used in this formula:
- TP (Typical Price): TP represents the typical price and is often calculated as follows: TP = (High Price + Low Price + Closing Price) / 3.
- SMA (Simple Moving Average): SMA is the simple moving average of the typical price over a specific period. It is calculated by taking the sum of the typical prices over a given time frame and dividing it by the total number of time periods. For example, if you want to calculate a 20-period CCI, you would sum the last 20 typical prices and divide by 20.
- MAD (Mean Absolute Deviation): MAD represents the sum of the absolute values of price changes above or below the moving average of the typical price. In other words, it measures how much each typical price deviates from the moving average when comparing the two.
The CCI indicator oscillates between 100 and -100 levels as a result of these calculations. A CCI value above 100 indicates overbought conditions, while a value below -100 indicates oversold conditions. Therefore, CCI is an indicator used to identify overbought and oversold conditions and potential reversals.
How to Trade with the Commodity Channel Index (CCI)
When learning the CCI, many people look for a simple Commodity Channel Index strategy they can use in their charts. One common Commodity Channel Index strategy is to watch for moves above +100 or below –100. These levels help show when the price is entering an active area. With this idea, it becomes easier to build a clear trading plan. Another Commodity Channel Index strategy is to wait for the indicator to cross back inside the +100 to –100 range after a strong move. Some use this as a sign that the trend may be slowing down. With moving averages or basic price patterns, this Commodity Channel Index strategy becomes easier to follow.
A more advanced Commodity Channel Index strategy mixes CCI with market structure. By checking the indicator together with a break of structure or order blocks, a person can find cleaner entry points and make steady decisions. We use the Commodity Channel Index (CCI) to analyze price movements on a given timeframe and identify possible trading signals. Different strategies can be developed to generate buy and sell signals with the CCI. Let's look at two of the most common strategies:
Turning Signals from Overbought and Oversold Zones
When CCI
rises above 100 and then reverses, it can be a sell signal. This suggests that
a reversal or pullback may occur after overbought conditions. If CCI reaches
-100 or lower and then the downward trend reverses, it can be considered a buy
signal. This indicates a possible reversal after oversold conditions. See the
example on the daily chart of Natural Gas below:
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| Natural Gas chart with CCI Indicator turning signals |
After seeing this example, notice how the price reacts around these levels. The CCI does not always give a perfect signal, so it is useful to combine it with trend analysis or support and resistance zones. By watching these turning points carefully, you can plan entries and exits with more confidence. Always remember to manage risk, as the market can stay overbought or oversold for extended periods.
Divergence Analysis
Monitoring divergences between CCI and
prices can also assist in generating buy and sell signals. For instance, if CCI
is rising while prices are falling, this can be interpreted as a positive divergence and a buy signal. Conversely, if CCI is falling while prices are
rising, this can be seen as a negative divergence and a sell signal. See the
example on the 4-hour chart of Brent Oil below:
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| CCI Indicator Signals on Brent Oil |
Looking at the 4-hour chart, you can see how divergences sometimes signal a shift before the price actually moves. In this case, a positive divergence hinted at a prospective bounce, while a negative divergence warned of a pullback. These signals work best when combined with other indicators or chart patterns. Keep an eye on volume and previous highs or lows to make the signal stronger. Remember, divergence shows a possibility, not a certainty.
How to Find the CCI Indicator Best Settings
Many people want to know the CCI indicator best settings so they can read the chart more clearly. Some prefer to use the default period of 14, and they feel this is one of the CCI indicator best settings for short-term moves. It reacts fast and gives quick signals. Others like a longer period such as 20 or 30. For them, these values are the CCI indicator best settings because the moves look smoother and easier to read. When the period is longer, the chart becomes calmer and helps a person stay focused on the main move.
There are also cases where someone uses two CCIs at the same time. In this approach, one period is short and the other is long. Many say this mix gives them the CCI indicator best settings because it shows both short moves and main direction on the same chart. In the end, the CCI indicator best settings depend on the timeframe, the goal, and the way the chart is used. Testing a few options makes it easier to find the one that feels clear and comfortable.
⚠ Please note that trading in financial markets carries risks. It's important to maintain emotional control during trading. Avoid making hasty decisions and refrain from emotional-based trades. Like all other technical indicators, the CCI indicator has limitations and can produce false signals. CCI should not be used as a standalone trading strategy. Consider other technical analysis indicators, candlestick patterns, support and resistance levels, and combine CCI with them to obtain more reliable results.