Forex Indicator CCI
The CCI has a crossover
line at zero, and an overbought level at 100, while values below -100 are
regarded as signaling an oversold condition. The CCI is an oscillator.
Note: Past performance
is not indicative of future results.
Here we see the
indicator in action in the price chart above. It is interesting to note that
the CCI gives many false signals even at extreme values. For example, the
lowest value for our indicator, at -283.576 was recorded during a very minor,
and passing bottom on the chart. As with most high sensitivity indicators using
the ATR requires a lot of practice and patience in mastering it.
Calculation of the CCI
To understand how the
CCI is calculated, we need to understand three different, yet simple
mathematical concepts. The first is the typical price, otherwise known as the
pivot point, which is the average (mean) of the high, low, and close for a
trading period.
Pivot Point, Typical
Price = H + L + C)/3
The mean absolute
deviation (MAD) is the sum of the differences between the typical prices and
their moving averages over the indicator's period divided by the same. So,
MAD(TP) = Sum of
(TP-SMA(TP))/Indicator Period
The indicator is then
calculated according to the formula below:
CCI = (TP- (SMA (TP)/
0.015*MAD(TP))
Here what we do first
is subtracting the simple moving average of the typical price from the typical
price itself (TP-SMA(TP). If you've used moving averages, it's very easy to
understand why this is being done. Remember, if the price is above the SMA, we
usually interpret this as a sign that the trend is an upward one, although its
momentum will be a matter of further analysis. Thus the first component (TP-
(SMA (TP) determines the relationship of the price to its moving average - and
also whether the indicator value is a negative or positive number. The
denominator of the equation serves the purpose of comparing this difference to
its historic average. Finally, the 0.015 factor is for amplifying the
fluctuations in the indicator, so that the changes are easier to note visually.
So what we do is in
fact just comparing the today's equivalent of the MAD with its historic value,
thus gaining an indication of how extreme today's price is in the context of
the past price action.
Trading with CCI
The CCI is used mainly
as an overbought/oversold indicator similar to other indicators like the RSI.
The overbought/oversold levels exists above 100, and below -100, respectively.
Many traders prefer to focus on divergence/convergences between the price and
the indicator with the purpose of reducing the number of trade signals, and
avoiding whipsaws.
The CCI was designed
for the commodity market, but any market where prices show a tendency to move
in cycles will prove to be fertile ground for its use. The forex market, with
its cycles dictated by interest policy, and the economic boom bust cycle, is a
suitable field for the application of the CCI.
It is most important to
remember that the CCI is a highly volatile indicator, and causes a lot of
whipsaws. Traders need to be conservative about their risk management
strategies when using it.
Accessibility
CCI is not as widely
available as some other indicators of the same type, such as the stochastics or
RSI indicators. MetaTrader, DealBook, TradeStation systems of major brokers do
offer it, but due its lesser popularity among forex traders, it is a good idea
to check beforehand with a demo account if it happens to be your favorite
indicator.
Conclusion
CCI can be very useful
with a few additional rules for validating its signals. As with the Williams
Oscillator, you can choose to act on a signal only if it remains valid for a
period of 10 days or so, leading to better, and more convincing
overbought/oversold signals. Or you can combine the CCI with other indicators
of different types for filtering out faulty signals. The key to using the CCI
successfully is a careful approach to risk controls. It is volatile, so you
should be prepared for unexpected outcomes and set your trading scenarios up in
accordance.