CCI stands for Community Channel Index. It was developed by Donald Lambert in the 80s (I not sure if he has any relation with Adam Lambert though). The CCI was initially developed to measure the cyclical turns of the price. Now it is a popular indicator among others. Many uses have been developed for CCI over the years. One trader that made CCI famous was Ken Wood (a.k.a. Woodie). He is well known trader and developed one complete system that is profitable with CCI. I just came across this indicator not long ago, and decided to read more about it.
The CCI is calculated by the deviation of “Typical price” from Simple Moving Average of a certain period of time. The calculation can be found on stockcharts website (http://stockcharts.com/school/doku.php?id=chart_school:technical_indicators:commodity_channel_index_cci). The default period would be 20. But the recommended interval should be 1/3 of a complete price cycle (from low to low or from high to high). The 20 default period will be suitable for most situations.
This is how CCI chart looks like. I have only plotted out the zero-line. In the price chart I have draw out 20SMA line. Notice how CCI behave around the zero line when price is above/below the 20 SMA
In short, the CCI represent deviants of how far the price is away from the Moving Average. There are many usages for this indicator. Here I would highlight some of the most common one.
Overbought and Oversold.
When the CCI goes above 100, the market is consider overbought. When the CCI goes below -100, it is consider oversold. The 200 and -200 mark will consider strongly overbought and oversold. Usually traders will look for reversal around this area.
“Zero line reject”
If CCI lines bounce at the zero line (or near the zero line), it is most likely the price going to reverse too. This is one of Ken Wood’s methods. If we draw a moving average line on the price chart, we could observe that the place where “zero line reject” happens, is the place where price see the moving average line as support/ resistance.
Zero line cross
When the prices cross above the zero line, it is bullish sign. It is good indication to go long. Same goes if the price crosses below the zero line, it is good signal to go short.
Divergence
Like other oscillator indicator, CCI can be use in divergence trading too. For more information on divergence, you may visit my post here.
Trend line
Ken Wood introduces trading method based on trend line. Not to be confused with trend line at price chart, this is trend line at the CCI. The method is similar to drawing trend line on the price. We go short or long based on the trend line break.
There you go. Few of the uses of CCI. I still learning to use this indicator, and will post more example soon
