Understanding Commodity Channel Index and how it Works
Traders and analysts use the CCI (commodity channel index) technical indicator to determine variable price action from security. Donald Lambert developed this technical indicator that falls under the momentum oscillator category in 1980. Donald’s intention for CCI was to alleviate timing demands associated with the emergence of seasonal or cyclical commodities markets.
To achieve his goals, Donald created a technique of correlating existing pricing variations against past ones. He would later discover the need for prevailing price comparison and a standardization mode. He developed the commodity channel index in various principles. Read on to find out.
A moving average acts as the standard by which prevailing price action is compared. Such an action occurs to retain the prevailing price correlation and eliminate any challenges associated with the past data set.
Often, financial instruments move in different intervals. Due to this, traders need the gadget to align the commodity channel index. Donald’s choice was .015 as the ultimate fixed divisor value in a CCI equation. Standardization of the commodity channel indexed within the .015 constant guarantees that up to 80% of the entire calculations will lie between the approved -100 and +100 ranges. Unlike in the past when the CCI facilitated seasonal commodities trading only, it became popular and had to be modified to fit in the trading of currencies, equities, and futures.
Reading the Commodity Channel Index Indicator
The CCI is located beneath the price chart and looks like a line wobbling in a box. It’s worth mentioning that the CCI is an endless oscillator but the span between 100 and -100 occurs by default. However, some trading programs allow traders to change the span based on their preferences.
While the default configuration for the common channel index is 20, traders can change it to suit their preferences. Remember, a short span CCI is more volatile and a high fraction will be below or above the 100 and -100 rates. A longer span CCI suggests that a small percentage will be off the -100 and 100 rates.
Traders interpret the CCI rates above 100 as signs of an uptrend while a -100 reading can be an indication of a downtrend. The commodity channel index indicator is a line wobbling between negative and positive rates. Seeing that the calculations are usually constant, CCI often fluctuates between the 100 and -100 intervals. According to some traders values that are higher than 100 lie in the overbought category, while those below -100 are oversold.
Using the CCI Indicator
Traders can leverage the basic CCI strategy to determine trading opportunities based on the oversold and overbought technique in a scope-bound market. The concept of CCI defines that many traders believe that in an overbought market condition the prices will start dripping when the market gets to the oversold phase.
In this case, traders can assume a long position or a short position once the CCI fluctuates below -100 or above 100. They can also pick an opposite position from the movement direction in the event of CCI extremes. The oversold and overbought analysis and rates are subjective. Still, traders use the sell and buy signals produced via the overbought and oversold notifications.
Assessing any market condition does not trigger price reversals and traders to launch the associated position immediately. This is because during strong trends the oversold or overbought conditions can go on for a non-specified period of time. To eliminate wrong signals some traders identify possible bearish and bullish differences between CCI movement and the price action.
Traders can create a CCI trading strategy with the different signals since they lead towards possible trend reversal because the momentum does not match the price movement. The bullish difference is visible when the price drops further when the CCI develops a high low.
A bearish difference occurs when the price increases and the CCI drops. In this case, traders may want to crosscheck their signals through other indicators especially when prices fluctuate in a massive trend. This is because signals can be inaccurate.
The common channel index technical indicator can be an effective element that offers authentic trading signals when used appropriately. Traders should modify their trading strategy and the CCI settings to eliminate possible risks that may arise from wrong signals.