Understanding the CCI Oscillator

[RichardCox 10]

The CCI oscillator (the Commodity Channel Index) was devised by Donald Lambert and started to gain popularity in markets during the 1980s as a means for identifying potential entry points for trading positions. This is accomplished by giving an assessment of whether or not a certain asset is overbought or oversold and while it might appear that this trading tool is specifically designed for the commodities markets (given its name), the CCI has grown in popularity amongst forex traders in recent years. Traditionally, the CCI has been used as part of trading systems that look to capitalize on breakout, trends, or range bound strategies but the CCI can also be used with retracements as a way of improving entry levels, so here we will look at some of the characteristics and potential strategy methods that capitalize on the strengths of the oscillator.

 

Oscillator Properties

 

To get a better sense of the mechanics of the CCI, we should first understand that it is an oscillator, which is a tool used in technical analysis that operates between two extreme values to display overbought and oversold conditions that are based on cyclical trend indicators. Oscillators tend to be most effective when clear trend movements cannot be identified (as with sideways, or range bound trading), with bullish reversals likely to come when prices are oversold (hitting the lower end of the oscillator range) and bearish reversals likely to come when prices become overbought (hitting the upper end of the oscillator range). Other commonly used oscillators include the RSI, Stochastics, and ROC.

 

Properties of the CCI

 

The CCI is essentially designed to measure the relative differences between a currency’s price (P), a moving average of that price (A), and the deviations from that moving average that are typically seen (D). This can be expressed in the following equation:

 

CCI = P - A / 0.015*D

 

The similarities with the CCI tool and other common oscillators come mostly from their ability to define oversold and overbought levels. In the CCI, these are seen below the -100 area and above the +100 area but in most cases (70 to 80 percent of the time) CCI values will fall between these range extremes. Because of this tendency, there is a greater probability that prices will reverse once CCI values reach overbought/oversold territory. Trades can be based on these events because of the high likelihood that the underlying prices will be forced to move in a corrective fashion and return to levels that are more representative of the asset’s true value.

 

Using CCI for Retracement Positions

 

Since the CCI tool displays these characteristics, it should be remembered that the oscillator can be used in ways that vary from the more common approaches. Breakout strategies,for example, are often criticized because of their inability to allow traders to “buy low, sell high” and this criticism can be extended to CCI usage as it fails to capitalize on the true strength of the oscillator. Alternatively, retracement strategies offer something of a solution for this, as the dominant trend is generally clear and entry levels are preferable (lower prices for long positions, higher prices for short positions). Attached is a sample structure for a long position.

 

In this structure, there are a few supportive arguments for a long position. In the CCI reading, we can see that prices have become oversold within the dominant uptrend. The CCI level is significant in this case because it is an area that has seen sharp increases in the past. Price activity itself is also clinging to the confluence of moving averages, as well as hitting the 38.2% retracement of the larger rally.

 

With the combination of these factors showing agreement, traders could initiate long positions, in the low 0.6600s, rather than waiting for a break of previous resistance above, allowing the trader to capture a much larger portion of the move. Of course, the reverse scenario would be seen for bearish positions but a similar set of rules would be in place in order to use the true strengths of the CCI oscillator and to position trade entries at more preferable levels.

[aaron77 10]

Developed by Donald Lambert and featured in Commodities magazine in 1980, the Commodity Channel Index (CCI) is a versatile indicator that can be used to identify a new trend or warn of extreme conditions. Lambert originally developed CCI to identify cyclical turns in commodities, but the indicator can successfully applied to indices, ETFs, stocks and other securities. In general, CCI measures the current price level relative to an average price level over a given period of time. CCI is relatively high when prices are far above their average. CCI is relatively low when prices are far below their average. In this manner, CCI can be used to identify overbought and oversold levels.

 

Calculation:

 

CCI = (Typical Price - 20-period SMA of TP) / (.015 x Mean Deviation)

 

Typical Price (TP) = (High + Low + Close)/3

 

Constant = .015

 

There are four steps to calculating the Mean Deviation. First, subtract

the most recent 20-period average of the typical price from each period's

typical price. Second, take the absolute values of these numbers. Third,

sum the absolute values. Fourth, divide by the total number of periods (20).