What is the Commodity Channel Index?

The Commodity Channel Index (or CCI) indicator, is an oscillator that was developed by Donald Lambert in the 1980’s. It compares the current price with an average price, typically over 14 periods. As an oscillator, it is an excellent tool to highlight overbought and oversold areas, and it can also help to identify bottoms and peaks in a trend.

Originally, the indicator was designed to be used for identifying trends in commodities as these were the markets the author focused on. However it is now used on a wider range of financial instruments.

Overbought and oversold

The default setting for CCI is 14 periods, meaning that it will calculate the recent price against the average price changes over 14 time periods. Observing the CCI you will see that, for the majority of the time, the indicator oscillates between +100 and -100. A reading of above +100 is considered overbought, whereas a reading below -100 would be considered oversold.

However, identifying the oversold and overbought areas can be tricky when it comes to placing a trade as theoretically any chosen instrument could move down or up without limits (or to zero in the case of a stock or commodity). That means that even when CCI is at extreme levels, the price can move higher and higher, or likewise the asset can continue moving lower even if the CCI is below the -100 level. As such, this indicator can give more accurate signals if the trader uses it with a volatility indicator, for example ATR.

Divergences

Besides helping with spotting overbought/oversold levels and reversals, CCI is often used to find Divergences. As a momentum based oscillator, Divergences between the indicator data and price movement should not be ignored as they can be a signal that changes in direction of the trend are near!

Let’s look at this in more detail:

A Bullish Divergence occurs when CCI is in the oversold area and CCI makes higher lows and the price makes lower lows. Conversely, for a Bearish Divergence, we should always look at the overbought area where the CCI makes lower highs and the price is making higher highs. This price action may foreshadow a trend reversal and can also provide confirmation points to the traders for entering the market.

You can easily add this indicator to your Skilling trading platform. You just need to type CCI to the indicator drop down menu and choose CCI. You may set up the colours as well as change the input data.

Skilling Summary
The Commodity Channel Index, as the name suggests, was originally designed for use on commodity markets. However, don’t be fooled by the name, it is certainly used nowadays by many traders across all markets. As an oscillator, it is not as popular as the Relative Strength Index (RSI), but nonetheless it is certainly a common method for spotting overbought and oversold levels. If you like to use oscillators in your daily analysis, then this is certainly a good option.