The commodity channel index (CCI) is a very popular indicator included in just about all technical analysis and charting software.
It was created by Donald Lambert. In 1980, he introduced his oscillator to traders through an article in Commodities magazine. Originally developed for commodities, it is now used by traders worldwide for stocks, futures and currencies as well.
Like the Keltner Channel, the commodity channel index uses typical price for it's calculation.
FORMULA AND CALCULATION
Typical Price (TP) = (high + low + close) divided by 3.
By measuring the relationship between price and a moving average, the CCI, like other oscillators attempts to determine overbought and oversold levels.
The CCI's formula is: CCI = (TP - MA) / .015 x D
(.015 is a scaling factor used to keep most values within the 100 to -100 boundary)
TP = Typical Price
MA = moving average
D = normal deviations from moving average (see other sources for details)
If you put up a chart with a 14 period CCI Index and a 14 period simple moving average, you'll find that the CCI is very similar to what you would get if you plotted price's distance above and below the moving average.
A DIFFERENT WAY TO USE THE CCI INDICATOR
The commodity channel index was, I understand, made to reveal the cyclical nature of a commodity and most likely had to be adjusted to whatever was being charted at the time. The most common interpretation of overbought and oversold values of 100 and -100 are not what I want to cover on this page.
What I would like to do, is introduce you to the technique of using trendlines directly on indicators such as the CCI rather than price. The process is similar to the divergence trading strategy except for the placement of the trendlines.
Only a single price - indicator divergence is required for a set-up with this strategy. Once a divergence has developed, a trendline is drawn on the indicator connecting indicator highs or lows.
The trigger for a trade is when the indicator crosses above or below the trendline at the close of the price bar. You'll notice that due to indicator divergence being a leading indicator, indicator breaks of a trendline will sometimes lead price breaks of a trendline.
This will make better sense if I just show you an example.
Remember, while divergence can be tempting to use, because of the potential to catch bottoms and tops, price often resumes it's trend after a break of a trendline whether it's placed on price or an indicator. So, always use a stop loss order in case price continues it's course.
Lets take a look at a 5 minute chart of QQQQ with a 14 period commodity channel index.
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