Commodity channel index trading strategy

When trading, one of the most important pieces of information to have is the ability to identify momentum—when it begins and when it ends. It can help you plan your next trade and to ensure that that trade is successful.

It is in the process of charting momentum that the Commodity Channel Index is especially effective, and that is regardless whether you are trading commodities, stocks or forex. The rationale behind the Commodity Channel Index or CCI is that it is an oscillator that measures the deviation from the simple moving average over the period.

Just like most oscillators, it has an overbought level and an oversold. If the CCI is relatively high then the pair is overbought and when it is relatively low, the pair is oversold.

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Unless the CCI is calibrated correctly it is practically worthless in identifying momentum cycles. Moreover, without correct calibration, it can generate plenty of false signals. But if you calibrated the CCI well it is an extremely efficient and powerful tool.

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The first step in calibrating the CCI is to identify when the current cycle began. Here are the basic rules for interpreting the CCI:. Possible sell signals :. Possible buy signals :. A possible supplement to the CCI is the use of candlestick patterns shown as supplements within the charts above , which can help confirm exact tops and bottoms throughout the CCI's "selling period" time in which it is above or "buying period" time in which it is below All price trading ranges are flexible, but the CCI is designed to take advantage of prices that have exceeded normal movements and are likely to snap back.

Traders might look to sell their holdings or covered calls when the CCI is very high or make an additional purchase when the CCI is very low. For more, see: Using Trading Indicators Effectively. It is extremely important, as with many trading tools, to use the CCI with other indicators. Pivot points work well with the CCI because both methods attempt to find turning points.

How to set up?

Some traders also add moving averages into the mix. Like any other momentum oscillator, the CCI is not designed to be used as a standalone tool. It may be more effective to complement this indicator with another technical tool, such as a price channel. Traders must also adjust their CCI entry and exit thresholds based on the volatility of the underlying security; for example, an index exchange-traded fund ETF is traditionally less volatile than an individual stock issue.

The Commodity Channel Index is an extremely useful tool for traders to determine cyclical buying and selling points. Traders can utilize this tool most effectively by a calculating an exact time interval and b using it in conjunction with several other forms of technical indicators. Technical Analysis Basic Education. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. These choices will be signaled globally to our partners and will not affect browsing data.

We and our partners process data to: Actively scan device characteristics for identification. I Accept Show Purposes. Your Money. Personal Finance. The idea behind the commodity channel index strategy is that during overbought market conditions, the expectations are that prices will start decreasing and when the market is in oversold state price increase is anticipated.

Of course, the overbought and oversold values and interpretation is subjective and also it is different for different types of instruments. However, traders use the buy and sell signals generated through the oversold and overbought alerts. Detecting either market condition does not mean that there will be price reversal and that you should immediately open the associated position.

The reason is that in times of strong trends, the overbought or oversold conditions can persist for an undefined amount of time, such as days, weeks, etc. You can see that at the red areas the CCI values are below indicating an oversold market condition which would mean that the trend will reverse, but the price continued its fall. Eventually, the trend does reverses and start moving upwards, but trading based on the CCI oversold signals could have been misleading because of the occurrence of whipsaw.

To filter out false signals, some traders are looking for potential bullish and bearish divergences between the price action and the CCI movement. Traders may setup a commodity channel index trading strategy using the divergence signals because they point toward potential trend reversal as the momentum is not in line with the price movement. Hence, bullish divergence is evident when the price makes a lower low while CCI forms a higher low.

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A bearish divergence is formed when the price makes a higher high, but the CCI makes a lower high. A word of caution here would also be that traders should confirm their signals using other indicators, especially when the price moves in a strong trend because the signals can also be misleading. Do not forget that the CCI can be a practical indicator which can provide valid trading signals as long as it is used correctly. Therefore, you should adapt the CCI setting, such as the number of periods and the trading strategy to eliminate potential losses, which may arise from false signals.

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