How Traders Use CCI (Commodity Channel Index) to Trade Stock Trends

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How Traders Use CCI (Commodity Channel Index) to Trade Stock Trends

How Do Traders Use CCI (Commodity Channel Index) to Trade Stock Trends?

Donald Lambert, a technical analyst, created the CCI, or Commodity Channel Index, which was first published in Commodities magazine (now Futures) in 1980. The CCI, despite its name, may be employed in any market and is not limited to commodities.

The CCI was initially designed to detect long-term trend shifts, but traders have modified it for use on various markets and timeframes. Trading using several timeframes gives active traders with additional buy and sell signals. Traders often use the CCI to identify the prevailing trend on the longer-term chart and to pinpoint pullbacks and produce trade signals on the shorter-term chart.

The strategies and indicators are not without flaws, and changing the strategy criteria and the indicator period may result in improved performance. Although all systems are prone to losing trades, establishing a stop-loss technique may help limit risk, and testing the CCI approach for profitability on your market and period is a worthwhile first step before launching trades.

Key Takeaways

  • The CCI is a market indicator that is used to follow market fluctuations that might signal whether to buy or sell.
  • The CCI compares the current price to the average price over a certain period of time.
  • The CCI may be used in a variety of ways, including over many periods to define dominating trends, pullbacks, or entry opportunities into that trend.
  • When market conditions become turbulent, certain CCI-based trading methods may generate several false signals or lose trades.

Calculating CCI

CCI is calculated with the following formula:

(Typical Price – Simple Moving Average) / (0.015 x Mean Deviation)

Understanding the Commodity Channel Index

The CCI compares the current price to the average price throughout time. The indicator oscillates between positive and negative territory, going above and below zero. While the majority of values, roughly 75%, fall between -100 and +100, approximately 25% go outside of this range, suggesting significant weakness or strength in the price movement.

Stock Chart with CCI Indicator. Image by Sabrina Jiang © Investopedia2020

The CCI calculation in the chart above is based on 30 periods; since the chart is monthly, each new calculation is based on the most recent 30 months. CCIs with periods of 20 and 40 are also prevalent.

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A period is the number of price bars that the indicator will consider while calculating. Price bars might be one minute, five minutes, daily, weekly, monthly, or any other timescale available on your charts.

The longer the time (the more bars in the computation), the less often the indicator will deviate from -100 or +100. Short-term traders favor shorter periods (fewer price bars in the calculation) because they give more indications, but longer-term traders and investors prefer longer periods (such as 30 or 40). Long-term traders should use a daily or weekly chart, while short-term traders may use the indicator on an hourly or even a one-minute chart.

Special Considerations

Indicator calculations are handled automatically by charting software or a trading platform; all you have to do is enter the number of periods you want to use and choose a timeframe for your chart (i.e., 4-hour, daily, weekly).The CCI indicator is available on Stockcharts.com, Freestockcharts.com, and trading systems such as Thinkorswim and MetaTrader.

When the CCI is more than +100, the price is much higher than the indicator’s average price. When the indication is less than -100, the price is much lower than the average price.

CCI Trading Strategy Basics

A simple CCI strategy monitors the CCI for movement above +100, which gives buy signals, and movement below -100, which creates sell or short trading signals. Investors may only wish to accept purchase signals, quit when sale signals appear, and re-invest when the buy signal appears again.

ETF Chart with CCI Basic Trade Signals. Image by Sabrina Jiang © Investopedia2020

When the CCI fell below -100 in 2011, the weekly chart above triggered a sell signal. This would have alerted longer-term traders to the possibility of a decline. More aggressive traders may have interpreted this as a short-sale signal as well. This chart shows how a purchase signal was generated in early 2012, and how the long position remains open until the CCI falls below -100.

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Multiple Timeframe CCI Strategy

The CCI may also be applied to other times. A long-term chart is used to identify the dominating trend, while a short-term chart is used to identify pullbacks and entry opportunities into that trend. A multiple timeframe approach is widely employed by more active traders, and one may even be used for day trading, since the “long term” and “short term” are relevant to how long a trader wants their holdings to last.

When the CCI on your longer-term chart rises over +100, it suggests an upward trend, and you only look for purchase signs on the shorter-term chart. Until the longer-term CCI falls below -100, the trend is deemed positive.

The graph above depicts a weekly upswing since early 2012. If this is your longer-term chart, only purchase signals on the shorter-term chart will be considered.

When utilizing a daily chart as the shorter period, traders often purchase when the CCI falls below -100 and subsequently rises over -100. It is thus wise to abandon the trade when the CCI rises above +100 and subsequently falls below +100. Alternatively, if the longer-term CCI trend reverses, it is a sell signal to terminate all long bets.

Buy Signals and Exits in Longer-term Uptrend. Image by Sabrina Jiang © Investopedia2020

On the daily chart, the figure above displays three purchase signs and two sell signals. Since the CCIon the long-term chart displays an upswing, no short bets are made.

Only accept short sell signals on the shorter-term chart when the CCI is below -100 on the longer-term chart. The decline will continue until the longer-term CCI rises above +100. On the shorter-term chart, you should enter a short trade when the CCI rises above +100 and then falls back below +100. Traders would then abandon the short position if the CCI fell below -100 and then rose above -100. Alternatively, if the longer-term CCI trend improves, exit all short positions.

Alterations and Pitfalls of CCI Strategies

CCI may be used to change the strategy rules to make them more severe or permissive. When employing various periods, for example, make the technique more strict by only taking long positions on the shorter timeframe when the longer-term CCI is more than +100. This decreases the amount of signals while maintaining a strong overall trend.

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Shorter period entry and departure regulations may also be changed. For example, if the longer-term trend is up, you may wait for the CCI on the shorter-term chart to go below -100 before purchasing, and then bounce back above zero (rather than -100). This will almost certainly result in a higher price, but it provides further comfort that the short-term retreat has over and the longer-term trend has resumed.

Before closing the long position, you may wish to allow the price to surge over +100 and then sink below zero (rather than +100). While this may imply enduring some minor setbacks, it may result in more earnings amid a good trend.

The data above are based on a weekly long-term chart and a daily short-term chart. Other combinations, such as a daily and hourly chart or a 15-minute and one-minute chart, may be utilized to meet your requirements. If you’re receiving too many or too few trading signals, try adjusting the CCI period to see if it helps.

Unfortunately, when circumstances get choppy, the technique is likely to generate several false signals or lose transactions. The CCI may swing over a signal level, leading in losses or an ambiguous short-term direction. In such circumstances, believe the initial indication as long as the longer-term chart reflects the direction of your entry.

This method does not contain a stop-loss, although it is advisable to have a built-in risk limit to some level. A stop-loss may be put below the recent swing low when buying, and above the recent swing high when shorting.

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