# Commodity Channel Index (CCI): Definition, interpretation and use

The CCI ( Commodity Channel Index ) indicator was developed by Donald Lambert. It is a versatile indicator that can be used both to identify a new trend and to detect extreme market conditions (overbought and oversold). In general, the CCI measures the current price level against an average price over a given period of time. In this way, the CCI takes high values ​​when the price is above its average and vice versa, the CCI will be relatively low when the price is below its average. This is how the CCI can be used to identify overbought and oversold levels.

### Commodity Channel Index calculation

The CCI formula is as follows:

CCI = (Typical Price (PT) – SMA (20) of PT) / (.015 x Main Deviation)

Typical Price (PT) = (High + Low + Close) / 3

Principal Deviation = the most recent value of the simple moving average is taken and this value is subtracted from each typical price of each period, the absolute value of each previous result is taken and all are added and, finally, divided by the number of periods.

0.015 is a constant introduced by Lambert that ensures that between 70-80% of the CCI values ​​are between -100 and +100.

### Interpretation of the CCI

As can be deduced from its calculation, the CCI measures the difference between the change in price and its moving average. Very high and positive values ​​will indicate that the price is well above its average which shows upward strength. On the contrary, very low and negative values ​​indicate that the price is well below its average, a sign of high weakness.

The Commodity Channel Index (CCI) indicator can be used as a leading indicator and as a coincident indicator:

• As a coincident indicator, rises above +100 reflect strong price action that can signal the start of an uptrend. Readings below -100 will indicate weakness which may signal the beginning of a downtrend.
• As a leading indicator, you can look for overbought and oversold conditions that help forecast a change in market sentiment and anticipate changes in the trend.

Let’s look at these two uses of the CCI in detail.

### Identification of the start of new trends with CCI

As seen in the CCI calculation, most of the values ​​taken by the indicator are between -100 and +100. A move beyond this range indicates unusual price behavior, either due to strength or weakness. Therefore, when the CCI rises above +100 or falls below -100, the movement in the indicated direction can be expected to continue. In general, the CCI will indicate greater upward force when it is positive and greater downward force when it is negative, but taking the zero line as a reference causes numerous false signals; the +100 and -100 lines offer better signals.

Let’s look at an example. The image below shows a daily chart of EUR / USD on which a 20-period CCI has been applied. As you can see, the 20-period CCI indicator is not suitable for detecting long-term trends. Also, as can be seen in the graph, CCI does not accurately record the highs and lows (tops and bottoms) of the trend, but it helps to filter a good part of the corrective movements allowing us to focus on the main trend.

### Detection of over-buy / over-sell conditions with CCI

As with any other momentum indicator, detecting overbought or oversold levels with the CCI can be quite inaccurate. One of the reasons is that the ITC, in theory, has no upper or lower limit and, therefore, the interpretation of an overbought or oversold situation becomes a subjective interpretation.

The detection of overbought and oversold zones with the CCI indicator is different depending on the market situation and the characteristics of the analyzed asset. Thus, for example, the ± 100 levels can be used in market situations in range but in situations of strong trend more extreme levels will be necessary, for example, ± 200 is a much more difficult level to reach and would represent a really extreme level in market situations in trend. These levels will also have to be adapted according to the volatility of the asset analyzed, the more volatility the more extreme levels will be needed to detect overbought/oversold conditions with greater reliability.

### CCI / price divergences

Divergences indicate potential market turning points because the direction of momentum (signaled by the direction of the CCI) does not confirm the direction of price (learn more about using divergences ).

A bearish divergence occurs when the price hits higher highs while the CCI hits lower highs, indicating that bullish momentum is losing steam. A bullish divergence occurs when price hits successively lower lows while the CCI readings show successively higher lows, indicating that bearish momentum is weakening.

Divergences can be a great tool for forecasting changes in price direction. However, faced with strong trends, many divergences can be seen before the change takes place. For this reason, it is advisable to confirm the forecast given by the divergences, for example using supports/resistances in the price whose exceeding would confirm the change. In the case of the CCI, divergences can also be confirmed by taking as a reference the zero level of the CCI; thus, a rise above the zero level of the CCI would confirm a bullish divergence and, similarly, a fall below the zero level would confirm a bearish divergence.

In the image above we can see an example of bullish divergence. We see how the CCI registers successively higher lows while the price continues to register new lows. The change to the bullish side is confirmed when the CCI rises above the zero level.

The top image shows a bearish divergence which, although confirmed by the CCI falling below zero, turned out to be a false signal.

As we have seen, the CCI indicator is a momentum oscillator that can be used to identify the start of new trends or the change in trend through divergences as well as to detect overbought / oversold zones. The versatile use of the CCI should be accompanied by other indicators or price analysis.

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### One Reply to “Commodity Channel Index (CCI): Definition, interpretation and use”

• […] of momentum indicators are the CCI (Commodity Channel Index) , RSI (Relative Strength Index) or […]

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