Trading with the Commodity Channel Index: Spotting Trends and Breakouts

Contributor, Benzinga
October 18, 2023

Traders look for signals in the market to predict how stock prices may move in the future. Technical indicators can possibly tip traders off on upcoming trends before the rest of the market notices. The commodity channel index is one of these indicators, and it measures the difference between a stock’s current price and historical price. Understanding how this indicator works can help traders detect trends and breakouts before everyone else notices.

What Is the Commodity Channel Index (CCI) Indicator?

The commodity channel index indicator is a resource that technical analysts use to predict stock price movements. This technical indicator reveals the gap between a stock’s current price and historical price. You can use the historical average price over any time interval you desire. Stretching out the CCI over a longer timeframe smooths out volatility while using the historical average for a smaller timeframe increases the impact of volatility.

How Does the CCI Indicator Work?

The CCI indicator can help traders spot trends and reversals. The formula can be positive or negative, with a positive number indicating the current price is higher than the historical average. If the CCI indicator has a negative value, the current price is below the historical average.

How to Calculate the CCI Indicator

Some online brokers and trading tools are able to calculate the CCI for you, but knowing the formula can give you a deeper understanding of how the CCI indicator works. You can calculate the commodity channel index with this formula:

CCI = (Typical Price - Moving Average) / (0.15 x Mean Deviation)

This formula looks simple enough, but the typical price, moving average and mean deviation have separate formulas.

Typical Price = ((High + Low + Close) / 3)

The trader must consider the timeframe for the typical price before calculating the formula. You can look at 10 days of trading data, 1 month or any other amount of time. The typical price is the average of the high, low and close for each trading day that is part of the timeframe.

Moving Average = Typical price / P

After calculating the typical price for each trading day in the time frame, you must then calculate the sum. Then, you must divide it by P (the number of periods/trading days) to identify the moving average.

Mean Deviation = (Typical price - MA) / P

Deducting the moving average from the typical price and then dividing by P lets you arrive at the mean deviation. The difference between the typical price and the moving average is in absolute value. That means a negative number will turn into a positive number for the mean deviation calculation.

Possible Uses of the Commodity Channel Index in Trading

The commodity channel index tells a trader about the relationship between a stock’s current price and historical average. While it’s good to know the gap between these prices, knowing how to interpret results from the CCI indicator can help to make more informed decisions. Here are some of the ways you can use the commodity channel index in trading.

1. Identify Overbought/Oversold Level

Traders can look at historic CCI levels to gauge if a stock may be oversold or undersold. An oversold stock has fallen significantly and presents a potential buying opportunity, while an undersold stock indicates the stock price has risen for quite some time and may be due for a pullback.

If a stock historically reverses its trend at a -300 CCI, a trader can wait for a stock’s CCI to reach that level before purchasing shares. Similarly, a trader can wait until the CCI reaches +250 to sell shares if the stock historically reverses at the +250 level.

2. Find Bullish/Bearish Divergences

Divergences tell you if the stock price and CCI are moving in opposite directions. A falling stock price and rising CCI may indicate a buying opportunity. This may cause traders to anticipate the downward trend losing momentum and shifting in the near future, but divergences are not the most reliable indicators. A trader should combine divergences with other technical indicators when evaluating stocks in this manner.

3. Determine New Emerging Trend

Most CCI values fall between -100 and 100. Seeing any movements above 100 or below -100 may indicate potential reversals and lead to new trends. A rising CCI, along with a rising stock price, can signal strength in the trend, just as a falling CCI can add more significance to a declining stock price.

Potential Advantages of Using the CCI Indicator

The CCI indicator can assist with stock trading returns because of its key advantages.

• Time your entries and exits: The CCI indicator can help you determine an opportune price point to buy and sell a stock.
• Determine the strength of the current trend: Some stocks may continue to accumulate gains, while others have a few days of gains followed by a steady stream of red days. The CCI indicator makes it easier to tell if the current trend is sustainable.
• Adjusting stop losses: If the CCI indicates a reversal might be on the way for a bullish stock, a trader can set a stop loss closer to the current stock price to minimize losses.

Limitations of Using the CCI Indicator

The CCI indicator is useful for technical analysts, but you should never rely on one indicator without additional data. Here are some of the limitations of using the commodity channel index.

• The indicator depends on how many trading days you use: The CCI will show different results if you look at 10 trading days vs. 30 trading days. It is possible to see a reversal within one timeframe and a continuing trend within another timeframe.
• The CCI is a lagging indicator: The stock market moves quicker than the CCI, and by the time this indicator suggests a reversal, it may have already taken place.
• It becomes less reliable during volatile markets: The CCI can produce false signals if the stock market is more volatile.

Forecasting Stock Price Movements with CCI

The Commodity Channel Index is one of many technical indicators that can help traders forecast stock price movements. Combining CCI with other indicators can lead to more accurate estimates and increase your potential profits with well-timed entries and exits. Traders should consider multiple technical indicators instead of relying on one indicator for their stock trades.

Q

Is CCI recommended for short-term or long-term trading strategies?

A

CCI can help with short-term and long-term trading strategies.

Q

What is an optimal value range for CCI?

A

The CCI is frequently within the -100 to 100 range. Any number above 100 or below -100 can indicate an upcoming reversal.

Q

What are a few alternative indicators that can be used alongside CCI?

A

Moving averages, relative strength index and stochastic oscillators are some of the alternative indicators that can be used alongside CCI.