Commodity Channel Index (CCI)

Implication

Trading Central identifies the following CCI events:

• A bullish event when the CCI rises above the +100% line.
• Another event signaling the end of the previous bullish trend occurs when the CCI subsequently falls below the +100% line.
• A bearish event when the CCI falls below the -100% line.
• Another event signaling the end of the previous bearish trend occurs when the CCI subsequently rises above the -100% line.

Description

Although the name CCI uses the term "commodity", the oscillator is commonly used for analyzing equities. A CCI is based on a comparison of price and moving average. The CCI is expressed as a percentage that oscillates between -100 and 100. However, these levels can be exceeded.

The Commodity Channel Index quantifies the relationship between the asset's price, a 20 bar moving average (MA) of the asset's price, and the mean of the absolute deviations (D) from that average. It is computed with the following formula:

Typically, if the price is greater than the moving average, then the CCI will rise towards or above the 100% line. If the price drops below the moving average, then the CCI will drop towards or past the -100% line. There are divergences and exceptions to this price/CCI behavior that technical analysts should be aware of when making trades.

Trading Considerations

Technical analysts use CCI in a couple of ways 1) to predict a price reversal, and 2) to determine overbought or oversold conditions.

To predict a price reversal, compare the direction trend lines for the price and CCI. If the direction of the price trend line is different than the direction of the CCI trend line a divergence is said to have occurred, and a price reversal may follow.

The most popular way to use the CCI is to watch for overbought or oversold conditions. A stock is considered overbought when it is reaches 100% or higher, and oversold when it is -100% or lower. Some technical analysts use CCI with the view that an overbought condition precedes a price drop, and that an oversold condition precedes a rise in price.

Colby, however, identifies the trading rules for using CCI as follows:

• Buy long when CCI rises above 100%

Buying long means that you are buying stock to own with the expectation that price will rise. You expect to earn a profit when you sell the stock at a higher price.

• Sell long when CCI falls below 100%

Selling long means selling stock that you own, ideally, at a higher price than when you bought it so that you will earn a profit.

• Sell short when CCI falls below -100%

Selling short means that you are selling stock that you have borrowed with the expectation that price will fall. If the price falls, you can profit by buying back the stock at a lower price and using it to replace the higher-priced stock that you borrowed. For example, if you sell stock for $100.00 per share, buy it back later at $70.00 per share, and then return the stock to the lender, your profit is $30.00 per share.

• Cover short when CCI rises above -100%

Covering short means that you are buying stock to replace stock that you have borrowed. To maximize your profit you will want to buy back the stock at a price that is lower than it was when you sold.