Tips on Technicals - Commodity Channel Index
Indicator type: |
Momentum indicator |
Used to: |
Time buys and sells based on overbought and oversold conditions |
Markets: |
All cash and futures, not options |
Works Best: |
Markets which have cyclical patterns |
Formula: |
CCI = |
Typical Price - Moving Average |
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0.015 * Mean Deviation |
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Where: |
Typical Price = |
Average of the High, Low and Close |
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Moving Average = |
Average of the Typical Price for "n" periods |
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Mean Deviation = |
Average Spread of the above for "n" periods |
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Parameters: |
Donald Lambert, its creator, suggests using a number of periods less than one-third of the cycle length, but the typical value is 20. Larger numbers of periods are less prone to whipsaws. |
Theory: |
The CCI creates an index that measures deviations from the average price as a statistical variation. Deviations from the average should present trading opportunities. It is essentially an indexed momentum study |
Interpretation: |
Most of the random fluctuations of the CCI should fall within a +100% to -100% channel. The rules of trading are to buy long when CCI rises to above +100%, and sell when CCI falls below +100%. Conversely, sell short when CCI falls below
-100%, then cover shorts when CCI rises above -100%.
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The chart above shows 200 days of CBT Corn futures with a 20-day CCI. This study is good at catching sharp moves but is prone to whipsaws during flat or slowing markets. Longer parameters will make it less sensitive and therefore less prone to false signals.
One alternate method for analysis is to close out long and short positions when the CCI crosses the zero line rather than when it re-enters the -100 to +100 zone. A more sensitive variation would be to close the position in a narrower -50 to +50 zone instead.
This study can also be used as an oscillator and as such can reveal divergences with price action. Note that when the study makes smaller peaks outside the -100 to +100 zone, a crossover back into the was suggested. In the corn chart, the July-August period showed frequent +100 crossovers while the market made higher highs. This could be viewed as a slight bearish divergence.