In this article, we will discuss
Traders rely on different technical indicators to identify price trends, analyse momentum and anticipate price reversals. One such indicator is the Commodity Channel Index (CCI). As its name indicates, this analytical tool was originally developed for use in the commodities market. However, with time, it has become useful for traders participating in other market segments too.
In this article, we explore what the CCI indicator is, how it is calculated and interpreted and how you can use it to make informed trading decisions.
What is the Commodity Channel Index?
The Commodity Channel Index is a measure of how the current price of a stock or security relates to its average price over a given period. If the current price is significantly above the average price, the CCI value rises. Conversely, if the current price falls below the average, the CCI value drops. While the indicator does not have any fixed maximum or minimum limits, its value can give you a clear idea of the direction and the momentum of price movement.
Calculating the CCI Value
The CCI indicator formula takes three key metrics into account — namely, the average price, the simple moving average (SMA) of the average price and the mean deviation of the average price. Check out this formula below.
Commodity Channel Index = (Typical Price — SMA of the Typical Price) ÷ (0.015 x Mean Deviation)
Let us decode what the metrics in the CCI indicator formula mean.
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Typical Price:
The typical price is the mean value of the high, low and closing prices over the period considered. The formula for this metric is as follows:
Typical Price = i=1P[(High + Low + Close) ÷ 3]
Here, P is the period used for the calculation. Generally, 20 days are considered when calculating this index. This means you have to calculate the typical price for each of the 20 days. However, depending on the time horizon for your trades, you can adjust this period as needed.
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SMA of the Average Price:
This is the simple moving average of the typical prices over the 20 days (or any other period you may have considered). To compute this, you must use the following formula:
SMA = i=1P(Typical Price) ÷ P]
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Mean Deviation:
The mean deviation measures how much the typical price over each trading day during the period considered varied from the moving average. To compute this, you need to first calculate the difference between the SMA and the typical prices for each day. Then, find the average of the absolute values of these differences.
This gives us the following formula for the mean deviation:
Mean Deviation = (i=1P|Typical Price — SMA|) ÷ P
This sums up the key metrics in the CCI indicator formula. You can then plug the values into the formula and compute the Commodity Channel Index.
Interpreting CCI Values
Once you find the CCI, you need to know how to interpret it and use the data and inferences to plan your traders in the securities market. The values of this technical indicator are plotted on a chart using three horizontal lines. Together, they resemble a channel, which is why the indicator is thus named. Once the values have been plotted, here is how you can interpret this metric:
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Positive and Negative CCI Values:
Generally, if the current price is more than the average price, the CCI takes on a positive value and is plotted above the zero level. Conversely, if the current price is below the average price, the CCI is negative and plotted below the zero line. At first glance, this should give you a fair idea of whether the stock’s price is on an uptrend or a downtrend. Consistently rising positive CCI values suggest that the stock price is moving up. However, falling CCI values mean the stock price may be dropping.
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CCI Above +100:
If the CCI breaches the +100 line, it indicates that the stock price has been steadily rising for several trading sessions in a row. This essentially points to an overbought market for that security, where the buyers have been driving the price upward. As with any strong uptrend, this price pattern may also be due for a downward reversal. So, if the CCI values breach this line, you may confirm oversold conditions using other indicators and plan to exit a current bullish position or open a new short position in anticipation of a bearish reversal.
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CCI Below -100:
When this index falls below -100, it means that the stock price may have been falling consistently for many consecutive trading sessions. This means that the stock is oversold and the sellers are dominating the market. As a result, the price will continue to fall till a potential bullish reversal occurs. You can use other technical indicators or candlestick patterns to confirm whether the stock is oversold and then either consider exiting your current short trade or opening a new long position in the market.
Conclusion
This brings us to the end of our handy guide on the CCI — a simple yet useful indicator for short-term traders. The process of calculating the index may be complicated, but most leading trading platforms today have this metric built into their analytical toolkit. You can simply add this to the other metrics you use to track the price of different stocks and securities and make trading decisions based on the CCI values.
For most stocks, the index will likely stay within the +100 and -100 zone most of the time. This means a potential trading opportunity presents itself when the index values breach these levels. That said, while the +100 and -100 levels are generally the turning points, they may not always apply to all stocks or securities.
Look at historical CCI data for the stock you are trading in to get a better idea of the trigger points for overbought or oversold levels for that stock. For instance, one stock’s price may reverse at +180 and -160, while another’s price may reverse at +240 and -80. So, context matters greatly when you use the Commodity Channel Index.
Disclaimer: INVESTMENT IN SECURITIES MARKET ARE SUBJECT TO MARKET RISKS, READ ALL THE RELATED DOCUMENTS CAREFULLY BEFORE INVESTING. The asset classes and securities quoted in the film are exemplary and are not recommendatory. SAMCO Securities Limited (Formerly known as Samruddhi Stock Brokers Limited): BSE: 935 | NSE: 12135 | MSEI- 31600 | SEBI Reg. No.: INZ000002535 | AMFI Reg. No. 120121 | Depository Participant: CDSL: IN-DP-CDSL-443-2008 CIN No.: U67120MH2004PLC146183 | SAMCO Commodities Limited (Formerly known as Samruddhi Tradecom India Limited) | MCX- 55190 | SEBI Reg. No.: INZ000013932 Registered Address: Samco Securities Limited, 1004 - A, 10th Floor, Naman Midtown - A Wing, Senapati Bapat Marg, Prabhadevi, Mumbai - 400 013, Maharashtra, India. For any complaints Email - grievances@samco.in Research Analysts -SEBI Reg.No.-INHO0O0005847
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