Greetings traders and welcome back to another Survival Guide.
Chris here, bringing you some more information.
Today, that information is going to be all about the CCI,
that is, the Commodity Channel Index.
This is an indicator that's a momentum oscillator that can
potentially help us better identify overbought and oversold
scenarios when read correctly.
We're going to talk about exactly what the CCI is, as well
as how to identify these overbought and potentially oversold scenarios.
Before we do that,
the first thing that we need to do is just put it on our
charts. So let's go ahead and go towards the top center and
click the "Show Indicator Options" button on the Finamark
platform. After we do that,
we need to add a new section because the CCI is an oscillator
that is listed below price. It does not directly overlay price.
Now that we have the second section, if we click on the second section,
scroll down the center column to the C's, we'll see
Commodity Channel Index. Give that a click, return to our charts,
resize it down a tad, and now we are good to go.
Without further ado, let's dive on into that material and
while we're going through these disclaimers, please click
that like and subscribe button down below because it allows
me to keep coming out with these videos for you guys. Here we go.
The Commodity Channel Index. It's been around for some time
and it is very, very popular, but let's start off with what it is.
We briefly got to look at how it looked on our chart,
here's a picture on the right hand side just in case you
already forgot, but the Commodity Channel Index is a momentum
oscillator that helps determine when the traded asset reaches
an overbought or oversold condition, potentially speaking,
if we analyze it correctly.
It is used to better assess the direction and the strength
of a trend, as well as to spot reversals by traders and potential
market extremes. The CCI indicator was developed by technical analyst and
mathematician, Donald Lambert, and was introduced in the Commodities
Magazine in 1980. As the name suggests,
the indicator's initial idea was to help increase trading
efficiency in the commodities market. It did that by mitigating
timing challenges associated with the entering of cyclical
and seasonal markets. At the time,
this was a significant problem for technical traders, as they
struggled to adequately forecast seasonal market changes and
to take into account the cyclical events resulting in the
price fluctuations. Thanks to its efficiency over time,
the CCI indicator became a favorite tool by traders to use
in the equity and the Forex markets.
But today, now the CCI is seen in many markets,
just about any type of any vertical, we're seeing the CCI
used. If you can chart it,
the CCI most likely can be applied to it. Most use the indicator
to determine their entry and exit points, or when to jump
into a trade, or potentially when to avoid a trade entirely.
It also helps traders identify whether they should add to
an existing position. The CCI helps traders by achieving this
through the process of comparing the current price fluctuations
in the traded instrument with the historical ones. On the
graph, the indicator is plotted as a line with a box that
fluctuates between negative 100 and positive 100.
For those of you that were dying to look at some math today,
well, here you go. This is the formula to calculate the CCI.
Now, once again, the calculation is done by the indicator for
us, so we don't necessarily ever need to do this, but I am
a big proponent on making sure that we understand how the
indicator we're using works. So that's what we have here.
If you're interested in recording this, I recommend pausing
the video and copying this mathematical formula down.
The methodology behind the calculation of the CCI is relatively
simple. The first thing that we do is we define the periods
that we want to analyze. Usually 14 periods are the default,
so that's normally what the CCI is going to be analyzing.
The fewer periods
we analyze, the more volatility we're going to see.
If we see a higher period setting, like a 21 period setting,
we're defining a smoother aspect in that volatility spectrum,
so it won't be nearly as volatile.
The next thing that we need to do is track the high, low, and
close for each period. That way, we can come up with the typical price value.
We will then compute the moving average of the typical price,
and to do that, we're going to sum up the last 14 typical prices and divide
them by 14, if we use the 14 period moving average default
setting. Then, we're going to calculate the mean deviation
for each period based on the formula mentioned that we were
talking about. If we take look at this formula, that's going to be our
road map. We're going to sum up all the values and then divide them
by 14. That's essentially all there is to it,
but once again, don't panic if you aren't good at math or
not interested in doing math, because the CCI indicator is
doing exactly this for us, but at least now, you know exactly
what it's doing for us.
To interpret the Commodity Channel Index,
it's important to understand that it represents the difference
between the current and average historical price change for
a particular security. High positive CCI values indicate that
the current prices are above their average, and this is a
sign of a trend strength. Low negative indicator readings
suggest that the prices are below their average, which is
a sign of market weakness. Traders can choose to use the CCI
as either a leading or coincided indicator. When uses a leading indicator, the CCI
helps recognize overbought and oversold market conditions
that might lead to a mean reversion reversal, as well as a
bullish and bearish divergence, or even potentially it foreshadows
some type of momentum shifts. On the other hand, when we use
it as a coincided, the CCI signals the emergence of uptrends.
When we have surges above the plus 100, or down trends that
are dipping below the negative 100,
these are examples of of strong trend confirmations.
70-80% of the time, the CCI will move in the range
between the negative 100 and the positive 100.
However, during the rest, that 20-30%, of
the time, it will be outside of those levels, which will indicate
an unusual strength or potential weakness in the current
market environment.
Such scenarios are considered a signal of a potential extended
move, and filters for the current bullish bearish market direction
itself. When the CCI ranges over the 100 mark, it is considered
favorable for the bulls.
When it's moving below the negative 100 mark, it is considered
a bear signal. In the general case, when the CCI moves from
negative or near zero territory to surpass to the 100 mark,
it is usually considered an indication for the beginning
of a new and strong uptrend.
If we see it go from the bottom to the top, this is usually
an indication of a powerful bullish trend emerging in the
market from a previously bearish market scape
Of course, the opposite holds true. If we watch the CCI
travel from on top to down on bottom,
we are on the lookout for a potential bearish trend thereafter.
Spotting overbought or oversold price levels is another way
traders use the CCI.
It's based on simple logic. When the indicator is above 100, positive 100,
the price is above its average. When the CCI is below negative
100, it is currently below its historical average. Alternatively,
zones over the plus 100 and below the minus 100 marks indicate
those overbought and oversold levels. When were over 100, we're
considered to be overbought and we're expecting some type
of mean reversion.
That means we're expecting the market to move back down towards
the historical average, because it is currently experiencing
an abnormally high degree of buying prowess. When we are below
the negative 100, the same logic applies, just flip the other
way. When we're below negative 100,
we can couple this with a read that the market will ultimately
be looking to move back towards that historical average at
some point, because it does not spend the majority of time
at or below the negative 100 mark, or at or above the positive
100 mark. We can trade this with the expectation that the
market will be sucking back in with the coupling of price
action. Another strategy that traders employe with the CCI
is by paying attention to the divergences between the
direction of the CCI itself and price.
This means that the CCI is going to be going one way, but
price is looking to be going the other. This is a divergence
because they are diverging in their paths.
They are no longer mirroring each other. The general accepted
theory in this case is that price will ultimately resume in the direction
of the CCI. In the case of the divergence that we have
listed here, we would be expecting to see price resume to
some bullish state, which it did indeed do. This is because
the CCI was rising while price was falling, and something
has to give. This can happen the other way around as well.
If the market itself and price action was rising, but the
CCI was falling, we would want to be on the lookout for the
market to fall. Now, it's important to keep in mind that the divergence strategy
is not a robust strategy by itself because it never properly
identifies an exact entry point. The divergence can last for
an extended period of time. Instead, when we notice the divergence,
it's important to be aware of it as a foreshadowing of what's
to come and make sure that our trading strategies are in
line with what is possibly going to happen.
As with all indicators, there are going to be advantages
to them, and there's going to be potential drawbacks.
Let's start off by taking a look at the advantages that the
CCI particularly likes to offer.
The first is the fact that it works in a variety of markets.
When you hear the "Commodity Channel Index" term for the very
first time, it's natural to think that it's designed to work in only
the commodities markets.
But the truth is, we can apply to equities, Forex, futures,
it just doesn't matter. The CCI is just a solid all-around
indicator that does well with any charting style.
The important thing to note is that the CCI should be adjusted
based on the instrument that we're measuring's historical volatility.
The second advantage is the fact that it's easy to comprehend,
even by beginners. The way the Commodity Channel Index is designed makes it
very easy to use and interpret, even by beginners.
All we have to do is adjust the CCI to the number of periods
we want to analyze, and we're off. Once we do that, we are ready
to go by using the CCI to give us those overbought and oversold
readings, like we already talked about. The more we use
it, the better we'll be able to spot the potential fake outs
and the potential juicy signals.
The third advantage is the fact that it's a very powerful
indicator. The CCI indicator can inform the trader about
various market developments, including both those overbought
and oversold price levels, the divergences, and even emerging
new trends. The fact that it also provides insight into the
price momentum and its strength, makes it one of the most
complete technical trading indicators out there.
Now, we'll cover the potential disadvantages, and the first
is the overbought and oversold levels are indeed subjective.
Due to being an unbound indicator, the CCI
can't guarantee that when it drops below negative 100 or
climbs above positive 100,
it is a fair indication of an oversold or overbought market by itself.
These are levels that are going to be dependent on being
reached based on the period that we have the CCI set to.
We do need to get comfortable with adjusting the settings
of the CCI and making sure that when the market has reached
these levels, it has responded accordingly to how we're anticipating
and using it. Number two is that it shouldn't be used as a standalone indicator.
This can be said for basically every indicator out there
but it was important to include as well.
This is just the concept that using price action to
sum up the concept of a buy or a sell being entered into
the market on the basis of the CCI alone is a very, very, very
nice layer of confirmation to add to our process of using
the CCI. Number three is it doesn't take news into account.
Once again, most indicators don't do this either. The fact
that the CCI doesn't take news into account means that if
it is measuring around a particularly volatile period that
was caused due to news, it might skew the results of the CCI.
so we need to take into consideration what's going on in
the markets and always be aware of the news.
The CCI can be summed up as a universal tool that can
potentially provide those overbought and oversold scenarios,
on top of potential market direction derived from the divergence,
or help us in the way of spotting emerging trends.
It's a very, very useful tool.
I strongly recommend checking out the CCI indicator
if you have not used it already. It's something that can
be very powerful, especially for those of you that are looking
to develop your own strategy and haven't quite found one
that fits you yet. When used in conjunction with outside price action,
it's a very powerful tool. But until next time folks,
Thank you for joining me, as always. Please do me a favor:
click that like and subscribe button down below, and I will
see you in the next one. Cheers folks!