What is the Commodity Channel Index?

The commodity channel index (CCI) was developed by Donald Lambert; the purpose was to identify movement in the cycles of commodities (stocks or bonds). These tend to move in cycles with highs and lows coming at predictable periodic intervals. Lambert recommended using one-third of the complete cycle as the time frame for CCI.

The length of the cycle is dependent on the CCI. CCI is used to measure the position of price in relation to the moving average. It is used in a technical analysis to figure out if an investment opportunity has been overbought and oversold. It is a qualifier for the relationship between the assets price, a moving average (MA) of assets price, and normal deviations (D) from that average.

The formula is CCI = PRICE MA / 0.015 x D The calculation has four steps (example uses 60 day cycle):

1.Last periods typical price (TP) = (H+L+C)/3. H = high, L= low C = close

2.Calculate the 20 day period simple moving average of the Typical Price (SMATP)

3.Calculate mean deviation. To do this first calculate the absolute value of the difference between the last periods SMATP and the typical price for each of the past twenty periods. Add all of the absolute values and divide by 20 to find the mean deviation.

4.Finally apply the Typical Price (TP), SMATP, the Mean Deviation and a constant. Note* constant is set at 0.015 for the purpose of scaling. Trading Guidelines set by Lambert were used to focus on movements above +100 and below -100 for the purpose of generating buy and sell signals. Seventy to eighty percent of CCI values are between these figures; so the buy and sell signals are only in force from twenty to thirty percent of the time. The security is considered to be moving toward a strong upward trend when the CCI is above +100 and the buy signal is given.

When the CCI is below -100 it is considered to be a downward trend and a sell signal is given. The CCI is growing in popularity among technical investors. Traders use the indicator to determine trends not only in commodities but equities and currencies too.

There are two basic techniques for using CCI.

1.Finding divergences which appear when the price hits a new high and the CCI can not go beyond a previously set high. The classical divergence is usually followed by a price correction.

2.Indicator of overbuying/overselling. These vary in the range of +100; values below +100 indicate an overbuying state. (Likelihood of correction of decay). The values that fall below -100 are used to inform of the overselling state (likelihood of correction increase.)

In conclusion this is an explanation of the commodity channel index.

Resources: http://stockcharts.com/school/doku.phd?id=chart_school:technical_indicators:commodity_channel_index_cci http://www.investopedia.com/terms/c/commoditychannelindex.asp http://www.metaquotes.net/techanalysis/indicators/commodity_channel_index/indicators/commodity_channel_index http://www.incrediblecharts.com/technical/commodity_channel_index.htm