Stocks and commodities cycle. The Commodity Channel Index (CCI) was created by Don Lambert. It is used to detect when cycles begin and end. Thus, it has been widely used as a buy and sell signal generator for both stocks and commodities.
Even the inexperienced observer is aware that stocks exhibit cyclical and trending behavior patterns CCI Small Pistol Primer. Obviously, traders want to buy early when a stock begins to trend and sell early when that trend comes to an end. The CCI can be a great help in spotting these trend changes. It examines current prices in the light of past prices without using any weighting factors that would artificially distort the raw data. For example, it uses a simple average rather than over-weighting data at one end of the measurement period (as in a weighted moving average or exponential moving average). Comparing current prices to a simple moving average also provides a moving reference point (it always reflects current conditions without biasing it). The equation for the CCI has a divisor that adjusts to reflect price variability. This divisor is smaller when the stock is non-trending (when the stock exhibits less variability) and larger when a breakout occurs (when the stock exhibits large variability). Thus, it reflects both prices and patterns of price fluctuation. In statistics, such numbers are called “measurements of variability. ”
The “current price” is not the closing price but the average of the high, low, and close. The divisor (or “measurement of variability”) is the average amount by which the “current price” deviates from the moving average of the “current price” during the period of measurement. The CCI computation is scaled so that 70% to 80% of the random fluctuations fall between -100 and +100.
When Don Lambert developed the CCI, tests were performed for the 5-, 10-, 15-, and 20-day periods of measurement. It was his opinion that although shorter periods like the 10-day CCI detected tops well for a variety of trend lengths, it was not as good at detecting “breakouts. ” Most indicators give an exit signal after the extreme price has been reached. The CCI, on the other hand, gives an exit signal at or before the extreme price with unusual frequency. To avoid the excessive whipsawing likely with shorter periods of measurement, Lambert settled on 20 days as the standard period of measurement. However, traders are encouraged to experiment to discover the period that works best for them. Many traders prefer to use 14 days and some prefer to use a combination of periods. Lambert suggests that the period chosen should be less than 1/3 of the cycle length (the cycle length is twice the trend length). This means the ideal CCI measurement will be less than 2/3 of the trend length. For example, the standard 20-day period is 1/3 of a 60-day cycle, and the 60-day cycle has a 30-day uptrend and a 30-day downtrend. Therefore, the 20-day period is most efficient for trends of more than 30 days. You must determine for yourself the trend duration for which you want to optimize the CCI.
Our own charts are plotted with a zero line and with horizontal lines at +100 and -100. Outside these lines we plot two others at +200 and -200 respectively. The latter are considered extreme readings. The rules for trading with the CCI were originally designed for short-term commodity traders. When the CCI crossed above the +100 line it was a buy signal. When it fell below that line it was a sell signal. Similarly, a short sale would be entered when the CCI crossed below -100 and it would be closed out when the CCI crossed above -100. The thinking was that these regions represented occasions when momentum was relatively high and when small profits could be captured in a few days. Since the CCI was originally formulated, other ways of using it have been found. Here are some of the ways our own traders use the CCI.