Commodity Channel Index - CCI

What

Developed by Donald Lambert, the Commodity Channel Index (CCI) was designed to identify cyclical turns in commodities. The assumption behind the indicator is that commodities (or stocks or bonds) move in cycles, with highs and lows coming at periodic intervals. Lambert recommended using 1/3 of a complete cycle (low to low or high to high) as a time frame for the CCI. (Note: Determination of the cycle's length is independent of the CCI.) A 20-day CCI would be recommended if the cycle runs 60 days (a low about every 60 days).

How

Calculate the last period's Typical Price (TP) = (H+L+C)/3 where H = high, L = low, and C = close.

Calculate the 20-period Simple Moving Average of the Typical Price (SMATP).

Calculate the Mean Deviation. First, calculate the absolute value of the difference between the last period's SMATP and the typical price for each of the past 20 periods. Add all of these absolute values together and divide by 20 to find the Mean Deviation.

The final step is to apply the Typical Price (TP), the Simple Moving Average of the Typical Price (SMATP), the Mean Deviation and a Constant (.015) to the following formula:

Typical Price – SMATP

CCI =     _______________________

0.015 X Mean Deviation TP

When

The one prerequisite to calculating the CCI is determining a time interval, which plays a key role in enhancing the accuracy of the CCI. Since it's trying to predict a cycle using moving averages, the more attuned the moving average amounts (days averaged) are to the cycle, the more accurate the average will be. This is true for most oscillators. So, although most traders use the default setting of 20 as the time interval for the CCI calculation, a more accurate time interval reduces the occurrence of false signals. Here are 4 simple steps to determining the optimal interval for the CCI:

1. Open up the stock's yearly chart.

2. Locate two highs or two lows on the chart.

3. Take note of the time interval between these two highs or lows (cycle length).

4. Divide that time interval by three to get the optimal time interval to use in the calculation (1/3 of the cycle).

Note that the CCI actually looks just like any other oscillator, and it is used in much the same way. Here are the basic rules for interpreting the CCI:

Possible sell signals:

The CCI crosses above 100 and has started to curve downwards.

There is bearish divergence between the CCI and the actual price movement, characterized by downward movement in the CCI while the price of the asset continues to move higher or moves sideways.

Possible buy signals:

The CCI crosses below -100 and has started to curve upwards.

There is a bullish divergence between the CCI and the actual price movement, characterized by upward movement in the CCI while the price of the asset continues to move downward or sideways.