Commodity Channel Index

In this article we will be covering an oscillator technique (oscillator techniques indicate overbought and oversold signals and exhibit divergence between the indicator and the security price) called the 'Commodity Channel Index' (CCI) that was created by Donald Lambert. It featured in a book the developer wrote called, 'Commodity Channel Index: Tools for Trading Cyclical Trends”. The name suggests that this technique can only be used for commodities, however it has also been applied to equities and currencies.

How the CCI is used

As mentioned above, as with other oscillators, the CCI indicates overbought and oversold positions. That is, when the indicator is above the +100 level, it suggests the market is overbought and that it could be a selling opportunity. Conversely, when the indicator below the -100 level, the indicator suggests the security has been oversold and a buying opportunity might exist.

The other technique used with the CCI is when it's used with divergence. We have covered divergence between oscillator techniques in previous lessons.

Manual Calculation

Please feel free to skip this section if you are happy to rely on the figures supplied by your charting package!

Firstly, you need to calculate the average price (AP) for the period (n), then a moving average over a pre-determined period of time. Then calculate a mean deviation over the same pre-determined period of time, and then finally to calculate the CCI you minus the moving average from the Average price then divide this by the mean deviation multiplied by 1.5%.

• Average Price (AP) = (high + low + close)/3
• Moving Average (MA) = (close 1 + close 2 + close 3 + ... + close n)/n
• Mean Deviation (MD) = ([MA last – AP1 [+] MA last – AP2 [+...+] MA last – Ap{n}])/n
• CCI = (AP – MA)/(0.015 * MD)

Example

The chart 1 (below) is of Coates Hire, COA from May 2006 to May 2007.

Chart 1

Notice in chart 1 (above) that the yellow area indicates the overbought regions and the aqua areas indicates the oversold regions. Some of those signals work quite well, while other do not. The period of time (n) used in the above example is 14, which is the default setting of most charting packages.

Chart 2

In chart 2 (below) we attempt to calculate the 'obvious cycle' which is the one recommended by Lambert. Therefore we change the time period (n), we do this by identifying two highs or two lows in the yearly chart. In chart 2 we have highlighted two highs.

The first high occurred on the 10^th July 2006 and the second high occurred on 26^th October 2006. This equated to roughly 118 days, Lambert suggests dividing this figure by 3 to enter the optimal time period. Therefore in the above chart the n parameter has been changed to 39 days. Compare chart 2 to chart 1 and you will notice that chart 2 is slightly more accurate than chart 1, as well as having less signals.

Chart 2

As always, it's important to use more than one technical indicator when making trading decisions.