How to Use the Commodity Channel Index (CCI) for Better Trading

Short-term extremes in prices indicate overbought and oversold conditions. They occur when the price of a currency on the Forex market has gone too high or too low. For an experienced trader, such market conditions indicate that a reverse reaction should be expected and a trend reversal is inevitable. Therefore, indicators that determine overbought and oversold levels are extremely important for building competent trading strategies.

One of the most popular indicators in this category is the CCI indicator. In addition to trend reversals, it is used to find divergences. Initially, it was focused on commodity markets, but its effectiveness inspired traders to apply it to trading other assets as well. As a result, it moved to Forex and many other markets.

What Is the Commodity Channel Index (CCI)?

To catch the CCI indicator meaning, you need to understand the beliefs of Donald Lambert, who proposed it. He believed that market prices deviate from the average level not randomly but in accordance with certain patterns. This means that cyclical trends can be identified with the tools of technical analysis. The Commodity Channel Index was proposed to determine price variation from the statistical mean.

What is CCI indicator benefit for a trader? It helps evaluate the following essential characteristics:

• The direction of the price trend;
• The strength of the trend;
• Divergence between price and indicator;
• Overbought and oversold situations;
• Price reversals.

In practical terms, it helps identify additional entry points, which allows you to make effective decisions when opening positions.

How Does the CCI Indicator Work?

CCI stock indicator shows the deviation of the current asset price from the average value. Therefore, traders distinguish three zones on the chart:

• The neutral zone is located around the zero line, which is equal to the average value of the asset price over a certain period. The boundaries of this neutral zone are determined by the levels +100 and -100. While the currency price fluctuates within the neutral zone, the market is relatively calm.
• The overbought zone is above the level +100.
• The oversold zone is below the level -100.

When the asset price hits these extreme levels, the trader understands that a trend reversal should be expected soon.

Formula

The CCI formula contains a constant of 0.015, proposed by the author of the index. It is needed to separate typical deviations from atypical ones.

CCI = ( typical price of the asset - moving average) / (0.015 x mean deviation)

or

CCI = (TP - MA) / (0.015 x MD)

Calculation

How is CCI calculated? You don't have to perform this task manually because the trading software can do it much faster and without any mistakes. But to understand it more deeply, study the CCI calculation algorithm:

Interpreting the CCI Indicator

The CCI technical indicator is interpreted like any other oscillator. The asset price fluctuates around a typical value, and the trader should track when it goes into the oversold or overbought zone. This will signal an imminent trend reversal. But keep in mind that the values of -100 and +100 are conditional since the Channel Commodity Index is unbound. The trend reversal can occur at other levels as well. Donald Lambert, highlighting the +100 and -100 zones, believed that crossing the +100 level indicates a bullish market, and crossing the -100 threshold indicates a bearish market. But later, traders supplemented this initial value with oversold and overbought zones. They are determined by historical data of previous reversals.

Trading Strategies Using the CCI Indicator

How to use CCI indicator in real trading? Professional traders include it in many strategies and often resort to it as a confirmation signal. The best Forex robots also take CCI into account when making decisions regarding opening and closing trading positions. Here are the most common approaches to using the Commodity Channel Index indicator for accurate prediction of trend reversals.

Simple CCI Strategy

CCI indicator strategy can be simple if you only consider the -100 and +100 levels. In this case, Donald Lambert advises to follow this rule:

1. If the CCI Forex rises above +100%, you should open a long position. When it falls below +100%, close the position.
2. If the CCI Forex falls below -100%, you should open a short position. Close it when the index rises above -100%.

CCI Divergence Trading Strategy

CCI divergence indicator gives strong signals about the upcoming trend reversal. However, instead of a trend reversal, a price correction may also follow. Usually, the divergence between the price trajectory and the CCI indicator occurs at the end of a long trend. Therefore, divergence gives a strong signal to sell/buy the currency, depending on whether it is a bearish or bullish divergence.

Combining with Other Indicators

If you want to build a more complex Commodity Channel Index strategy, you need to combine it with other indicators. This technical indicator works well in the following combinations:

• CCI + Parabolic SAR + MACD
• CCI + Fibonacci correction
• CCI + Moving Average
• CCI + Bollinger Bands
• CCI + Delta
• CCI + Big Trades
• CCI + Cluster Search and others

Commodity Channel Index vs. RSI

Both indicators are momentum oscillators, so you can use a CCI trading strategy or an RSI-based strategy. What makes them different is that the RSI indicator's range is fixed. Therefore, it is easier to interpret than the CCI, which is unbounded.

Traders argue about which indicator is more effective. You can contribute to the Commodity Channel Index vs RSI debate by trying to use each of them separately in your trading strategy.

Commodity Channel Index vs. Stochastic Oscillator

Both indicators allow you to identify overbought and oversold conditions. But the Commodity Channel Index will give you an earlier signal of a possible trend reversal. The Stochastic Oscillator will help you assess the strength of the current trend. Therefore, you can use both of these indicators to make more accurate predictions.

Advantages and Limitations of the CCI Indicator

The CCI indicator was proposed just over 40 years ago, but it quickly spread to all trading markets due to its obvious advantages:

• The Commodity Channel Index pattern is visually easily distinguishable and can be used even by beginners in trading.
• You can easily determine the market trend and make decisions regarding opening positions.
• This indicator can be adapted to any timeframe.
• If you use other technical indicators as your main ones, the CCI will act as an effective confirmation signal.

There are also limitations to the use of the Commodity Channel Index:

• It is not effective during rapid market changes. The CCI uses historical price data, which is why this is a lagging indicator. At moderate rates of change, this does not matter, but at rapid rates, its insights are not relevant.
• Unbounded oversold and overbought levels create difficulties in interpretation. In this regard, the RSI indicator is simpler.
• With low market volatility, the CCI can also give false signals.

Conclusion

The CCI indicator explained will help you improve your trading strategies. It simplifies your decisions regarding opening positions, as it indicates the dominant trend, overbought/oversold conditions, and possible trend reversals. CCI has proven its efficiency in practice, so many traders use it regularly in combination with other indicators.

However, remember that it works based on the assumption that trends are cyclical and deviate towards extremes according to certain laws. Therefore, if you share other beliefs, you should pay attention to those indicators that consider the market a chaotic environment.

Also, do not try to calculate CCI Forex manually. This is too labor-intensive work, which does not make sense, since the software copes with this task quickly and efficiently. Trading strategies based on the CCI indicator are part of the primary arsenal of trading robots. Therefore, if you want to trade with CCI without errors, entrust this task to your automated assistants.