Introduction – What’s the Commodity Channel Index Indicator?
The Commodity Channel Index (CCI) indicator came to being in 1980, being developed Don Lambert as a commodity trading indicator hence the name. Today, it is also used in other financial markets. The CCI is an oscillator which can be used to detect areas where the market or the asset is oversold or overbought.
Composition of the CCI
The CCI is a relatively simple indicator. It has an indicator line, as well as the overbought and oversold areas. There is also the zero line which plays a crucial role in how trade signals are obtained. The indicator is listed as an oscillator.
How to trade Forex with the CCI Indicator:
It is paramount to understand the composition of the CCI indicator prior to usage as a trade indicator. The CCI values range from -150 to 150. The zero line divides the bullish from the bearish CCI values. The CCI can be used as a trend trading indicator as well as a reversal trade indicator.
- As a Trade Reversal Indicator
The best application of the CCI as a reversal trade indicator, is when the CCI line is located between 80 and 100 (overbought) and between -80 and -100 (oversold). This is not the only parameter used; there must be something on the charts that supports a reversal move. This could be in the form of a reversal candle pattern. The CCI is generally not very reliable as a reversal trade signal.
The CCI can be used as a trend trading indicator when it is used to trade divergence. This application of the CCI will usually yield better results here than when used as a trend reversal indicator. In trading divergence, the trader looks for areas where the indicator line’s tops and bottoms pull away from the corresponding tops and bottoms of price action. At some point, the price action will correct itself in the direction of the indicator’s movement. It is this correction of deviation that the trader attempts to catch.
The trader must look for a technical basis of entry when looking to trade the correction of divergence. Trade entries are not just randomly made just because a divergence has occurred.
Here is a demonstration of what a trend trade with the CCI using divergence looks like. In this image, we see a number of things:
- The initial trend is downwards, displaying lower lows.
- The CCI’s lows are rising, forming higher lows.
This presents the divergence opportunity. But how does the trader make use of the CCI to be able to trade this setup?
The break for the trader comes with the formation of a doji. A doji pattern is like a precursor for a reversal of price. It is like a pause factor: buyers and sellers are almost as equally active in the market and no one prevails. Then the CCI really takes off and crosses above the zero line. Price action starts to turn upwards in an attempt to correct the divergence, with the candle following the doji closing at a higher level than the doji closing price.
This is just an example of how a trader can decide to use the CCI to trade a divergence. Here is another example.
In this example, the price action is forming higher highs while the CCI is forming lower highs. Therefore, the trader’s position has to try to catch the correction of price divergence in the downward direction. In other words, the trader would be looking to SELL. Like before, a justifiable entry has to be made using any technical analysis parameter. In this case, there is a hammer candle followed by a doji. As soon as a bearish candle forms which closes lower than the low of the doji forms, the trader may consider taking the trade.
The Commodity Channel Index would of course, work very well when used in trading commodity assets. It is up to the trader to practice with this indicator to understand how it fully works.