The Commodity Channel Index is a technical indicator invented in 1980 by Douglas Lambert. The indicator itself was initially designed to help with engineering problems that dealt with erroneous signals. However, it’s been applied to many other things, including financial markets, and despite its name, the indicator works just as well on Forex as commodities.
Price oscillator
The CCI is a useful price oscillator and it’s fundamental use is to calculate where the price of a currency is in relation to its statistical average. The oscillator is unbound with values able to exceed +100 and -100 on both sides. As such, values over +100 are considered to indicate a highly overbought condition while values under -100 indicate an oversold condition.
It’s therefore a flexible indicator that can be utilized in momentum and mean reversion strategies. The most common method is to buy the market when CCI is below -100 and sell when the indicator is above +100. It’s also possible to use the CCI in connection with other indicators such as volume, ATR or with moving averages to smooth the oscillator and identify divergence.
While overbought and oversold levels offer good points to buy and sell, it can often pay to treat the signals differently. A market where the CCI goes through the levels gradually is more likely to continue on its way, while a market where the CCI spikes up or down through the levels quickly is more prone to reversal. These are important characteristics for mean reversion traders.
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The CCI is versatile and as we have seen it does have some important characteristics which is why it’s handy to know the rules that come with trading the CCI:
Steps for using CCI
Steps for longs
1. On daily or hourly charts, the CCI indicator should start with an input of 20.
2. Always make a note of the last time the CCI registered a reading of greater than +100 before dropping back below the +100 zone.
3. Next, measure the peak CCI reading and make another note.
4. If CCI trades above the +100 again and if the value exceeds its prior peak reading, go long at the close of the bar.
5. Make a note of the low of the bar and use this as your stop.
6. If the trade moves in your favor by at least the distance between your entry and stop, sell half of the position and move your stop to break-even.
7. When the position moves to two times or more than your stop, sell the rest of the position.
Steps for shorts
1. On daily or hourly charts, the CCI indicator should start with an input of 20.
2. Always make a note of the last time the CCI registered a reading of greater than -100 before dropping back below the -100 zone.
3. Take a measure of the trough CCI reading and record it.
4. If CCI trades below the -100 again and if the value exceeds its prior trough reading, go short at the close of the bar.
5. Make a note of the high of the bar and use this as your stop.
6. If the trade moves in your favor by at least the distance between your entry and stop, cover half of the position and move your stop to break-even.
7. When the position moves to two times or more than your stop, cover the rest of the position.
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