The commodity channel index is a momentum indicator developed by Donald Lambert. It reveals the moment when a new trend begins and highlights overbought and oversold conditions. It measures the current price relative to a moving average and oscillates between +100 and -100. Theoretically, the market is overbought when the CCI is above +100 and it is oversold when the CCI is below the -100 level. Please note that theory and reality are not always the same. Quite often, the commodity channel will duplicate or will accurately reflect the price’s movement. Nevertheless, it is common to notice divergence between the CCI indicator and the price. This divergence comes in the form of fake divergences and valid divergences. All valid signals are validated by the price. The CCI is also a leading indicator, but one must know how to use a leading indicator in order to avoid sour disappointments.
After careful observation of this magnificent indicator, we have noticed, shocking resemblances between the commodity channel index and the humble “Bollinger bands”. Bollinger bands are trading tools created by John Bollinger in 1980 to highlight the dynamism of volatility. The bands include one middle band as well as two outer bands that deviate from the middle band. Traders use standard deviation plus and minus two when plotting the “Bollinger bands”. Similarly, the CCI indicator consists of one middle band (zero level) and two outer bands. The upper band is the +100 level and the lower band is the -100 level. It is obvious that the CCI indicator is seeking to play the role of the price within a Bollinger. When one substitutes the price for the CCI indicator and moves the “Bollinger bands” to the outer +100 and -100 levels, there is no doubts that the Bollinger bands and the CCI indicator become perfect substitutes for each other.
After these clarifications, we can efficiently use the commodity channel index (CCI) indicator. Please note that when the CCI period 14 is above +100, the price is usually at the upper band of the Bollinger 14, volatility two; when the CCI period 14 is below the -100 level, the price will usually be at the what is macd lower band of Bollinger 14, volatility two. When the CCI period 14 is at the middle line, the price, in most cases, is at the middle line of the “Bollinger bands” 14, volatility two. When we compare the CCI period 50 to the Bollinger (50,2) and the CCI period 20 to the Bollinger (20,2), we find that there are many overt similarities between the Bollinger bands and the commodity channel index indicator. To compare the Bollinger bands to the CCI indicator, one must use the exponential moving average settings for the Bollinger bands. These settings are crucial. Both the CCI indicator and the “Bollinger bands” must have the same period before a valid comparison can take place. Divergences do take place. For instance, when the price is still at the upper band of the Bollinger (20,2) but the corresponding CCI period 20 has pulled back near the middle line (zero), there is a high probability but not a certainty that the price may also pull back to the EMA20. If the price is still at the lower band of the Bollinger (20,2) but the CCI 20 rallies up to the middle line (zero), the price, under normal conditions, will rally up to the EMA20. One can note the same observation when using the commodity channel index (CCI) period 50 and the “Bollinger bands” (50,2). Please note that the “TSTW24” uses the Bollinger (50,2). It is important to remember that the price is the number one indicator, because we are trading the price, not the commodity channel index itself. All valid signals received or derived from the CCI indicator are validated by the price. A signal is one thing, but the entry point is the key.
Trading the overbought and oversold CCI like a pro.
No indicators, either leading or lagging, will ever completely replace the price. Never ever forget that. We are trading the price, not the indicators. One should not seek to complicate trading but to simplify it. When the commodity channel index (CCI) indicator is overbought above the +100 level, many traders will quickly place orders to sell without further verification. These are traders who trade the indicator, not the price, and they will go from one trading system to another trading system and blame their lack of success on everything except themselves. Trading the indicators instead of the price is one major cause of consistent losing trades. The CCI is often overbought right from the beginning of a new up trend or during the third “Elliott wave”. While the educated traders are busy placing orders to buy, ordinary traders are selling and losing abundantly because they fail to recognize that a resistance is broken and validated as a support level, while the CCI is still overbought. Either that, or they did not recognize that a trend line has been broken and, retested and that the price has turned around. When the CCI indicator is overbought, it is alerting traders that, bullish momentum has increased and that the price is in a resistance zone (overbought), period. It does not mean that you should sell or waste your money. Traders must highlight the indicated resistance zone and follow the price. If the resistance is broken and the price finds support above the resistance zone, traders should buy even though the CCI is still overbought. Below are some simple trading rules that, one can follow.