How To Use Commodity Channel Index (CCI) To Make Better Trades

Commodity Channel Index (CCI) is quite useful for determining trend reversals as well as trend confirmations. CCI is generally used by traders for identification of new trends and also to provide warnings against extreme conditions. Let’s now take a closer look at the CCI oscillator.

What is a CCI Oscillator?

Commodity Channel Index was created by Donald Lambert in 1980. This oscillator measures the difference between the price changes of a stock with respect to its average price change over a given time period.

Nearly 70% to 80% of CCI value falls within the range of +100 to -100. When CCI indicator rises above +100 or falls below -100, it usually signals overbought and oversold levels in the market. However, CCI is an unbound oscillator, which means that there are no upside or downside limits. So, interpreting an overbought or oversold condition remains subjective.

The figure below shows a CCI oscillator

CCI and Trends

When the value of CCI is above +100, it means that the prices are very much above the average price. When CCI is below -100, it generally shows a weak price action.

The CCI oscillator can be used for identifying the upcoming trend.

  • When the CCI moves above +100, the stock is said to have entered into a strong uptrend
  • When the CCI moves below -100, the stock is said to have entered into a strong downtrend

CCI and Divergences

Whenever there is a bullish or bearish divergence in CCI and the price of the security, it signifies a shift in momentum. Hence, it can be used as an early indicator for reversal of trends.

  • A Bullish divergence occurs whenever the stock makes a lower low while the CCI makes a higher low.
  • A Bearish divergence occurs whenever the stock makes a higher high while the CCI makes a lower high.

The figure below shows a bearish divergence between price and CCI. As you can see, the price declined soon after the bearish divergence.

How to Use CCI for Making Effective Trades?

Following are the ways to use CCI for making better trades

Bullish Signs

  • During an uptrend, when CCI reaches zero line and bounces up from there, traders enter long positions. This is because zero line is one of the strongest points of support and resistance.
  • When the CCI is below -100, it is considered to be oversold. When CCI moves up from oversold levels, traders enter long positions.
  • When CCI moves above +100, traders enter long positions, as it signifies a strong uptrend. This position is closed when the CCI moves back below +100.
  • Whenever there is a bullish divergence (where the stock makes a lower low while the CCI makes a higher low), traders enter long positions.

Bearish Signs

  • During a downtrend, when CCI reaches zero line and goes below zero line, traders enter short positions. This is because zero line is one of the strongest points of support and resistance.
  • When the CCI is above +100, it is considered to be overbought. When CCI moves down from overbought levels, traders enter short positions.
  • When CCI moves below -100, traders enter long positions, as it signifies a strong downtrend. This position is closed when the CCI moves back above -100.
  • Whenever there is a bearish divergence (when the stock makes a higher high while the CCI makes a lower high), traders enter short positions.

Happy Trading!

Tara

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