Saturday, December 14, 2013

Commodity Channel Index (CCI)

Commodity Channel Index (CCI)

Developed by Donald Lambert, the Commodity Channel Index (CCI)measures the variation of a security's price from its statistical mean. High values show that prices are unusually high compared to average prices whereas low values indicate that prices are unusually low. Contrary to its name, the CCI can be used on any type of trading instrument, not just commodities.
The Commodity Channel Index (CCI) is calculated by first determining the difference between the mean price of a commodity and the average of the means over the time period chosen (where Mean is the exact middle between 2 extremes - MidPrice). This difference is then compared to the average difference over the time period (this factors in the commodity's own inherent volatility). The result is then multiplied by a constant that is designed to adjust the CCI so that it fits into a "normal" trading range of +/-100. For scaling purposes, Lambert set the constant at 0.015 to ensure that approximately 70 to 80 percent of CCI values would fall between -100 and +100. The percentage of CCI values that fall between +100 and -100 will depend on the number of periods used. A shorter CCI will be more volatile with a smaller percentage of values between +100 and -100. Conversely, the more periods used to calculate the CCI, the higher the percentage of values between +100 and -100.
Interpretation
The CCI is a versatile indicator capable of producing a wide array of buy and sell signals. However, there are three basic methods of interpreting theCCI: looking for divergences, trend line breaks, and as an overbought/oversold indicator.
A divergence occurs when the instrument's prices are making new highs while the CCI is failing to surpass its previous highs or when the the instrument's prices are making new lows while the CCI is failing to surpass its previous lows. These classic divergences are usually followed by a correction in the instrument's price.
Trend line breaks can also be used to generate signals. Trend lines can be drawn connecting the peaks and troughs of the CCI. From oversold levels, an advance above -100 and trend line breakout could be considered bullish. From overbought levels, a decline below +100 and a trend line break could be considered bearish.
The CCI typically oscillates between +100 and -100. To use the CCI as an overbought/oversold indicator, readings above +100 imply an overbought condition (and a pending price correction) while readings below -100 imply an oversold condition (and a pending rally).


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