The Commodity Channel Index (CCI) is an oscillator-type technical analysis indicator. It is used to spot an emerging trend and determine overbought/oversold levels. This indicator was first introduced by Donald Lambert in Commodities magazine in 1980. Originally developed to identify cycles in commodity trading, it is currently applied to a wide range of assets.
The CCI compares the current price of the asset with its average prices over a set period of time. When current prices are above the median level, the CCI is relatively high. Alternatively, when current prices are below the period’s average value, the CCI is relatively low. The indicator, therefore, provides means for overbought/oversold level identification.
The logic behind
The CCI measures the difference between the current price change and the average price change of the underlying asset. When the prices are above the average level, the indicator’s readings tends to be high. When the prices are below the average level, the readings will apparently be low.
The Commodity Channel can be used both as a leading and a supplementing indicator. When using it as a leading indicator, traders might want to trace overbought and oversold levels, as well as bullish and bearish divergences, to try to predict upcoming trend reversals.
When using the CCI as a supplementing indicator, surges above +100 can point to a strong price action and an upcoming uptrend. Plunges below -100 can point to a weak price action and a possible downtrend.
How to set up?
Setting up the Commodity Channel Index in the IQ Option platform is easy.
Click on the “Indicators” button in the bottom left corner of the screen. Go to the “Trend” tab and choose Commodity Channel Index from the list of available options.
Then click the “Apply” button if you want to use the indicator with standard parameters. You can also adjust the indicator to your liking. Note that when used with standard parameters 70 to 80% of CCI readings would fall between +100 and -100. The shorter the look-back period the more volatile the CCI will be with a smaller percentage of values between +100 and -100.
How to use in trading?
New trend
As mentioned above, 70 to 80% of all the CCI readings fall in the -100/+100 range. When the readings leave the boundaries, there is a chance something interesting is going on. Should the indicator cross the +100 boundary from below, some traders would expect a bullish trend. Due to a lagging nature of the CCI, the uptrend could have actually already be gone. In this case, it is a trader’s goal to determine whether it will last or not. And if yes, then how long.
Similarly, if the -100 line is crossed from above, some traders would expect a bearish trend.
Overbought/oversold
CCI is an unbound indicator, which makes identification of oversold and overbought levels a little bit tricky (yet not impossible). The underlying asset can continue losing its value long after CCI entered the oversold zone as well as appreciate even if CCI has been in the overbought position for quite some time.
The selection of overbought/oversold levels depends on the market and the asset that is being analyzed. In the Forex market, it is usually believed that the underlying asset is overbought when the CCI indicator is above the +200 mark, a truly hard to reach point. Likewise, if CCI dropped lower than -200, the asset is considered to be oversold.
Divergences
If directional momentum does not confirm the price, a trend can be expected to reverse soon. When CCI forms a higher low and the underlying asset makes a lower low, a bullish divergence occurs. Bearish divergence will appear when the CCI forms a lower high and the underlying asset makes a higher high.
It should be noted that during a strong trend divergences can be misleading.
Conclusion
The Commodity Channel Index is a versatile technical analysis tool that is used to spot emerging trends and determine overbought and oversold positions. It offers a good mix of accuracy and analyzing potential. Other indicators may be required to confirm signals send by CCI.
