The Commodity Channel Index (CCI)

Some indicators work well in trending markets while others work in consolidating markets. The Commodity Channel Index (CCI) works best in strong trending markets. Unlike other trend following indicators, the CCI is designed to limit whipsaws during choppy markets.

Created by Donald Lambert, the CCI is a price momentum indicator that measures the degree of variance of a security’s price from its statistical mean. Although originally developed for trading commodities, the CCI can be used for equities or indexes as well.

AIQ has a default time period of 90-days in the calculation of the CCI. Time periods that are too short can lead to whipsaws while time periods that are too long result in missed signals. The 90-day time period seems to be a good compromise.

In general, the CCI looks at prices relative to the average price. If the CCI is high, then prices for that security are higher relative to its average price. Conversely, if the CCI of a security is low, then prices are lower than the average price. 

In consolidating or sideways markets, the CCI tends to fall within the +/-100 range (the two horizontal lines on an AIQ chart). Whenever the CCI moves above or below this range, then it suggests a strong trend is in place. Therefore, when the CCI rises above +100 it suggests a strong
uptrend is underway and that long positions can be established. Long positions are closed once the CCI falls below +100. Conversely, when the CCI falls below –100 it means a downtrend is in place and short positions can be established. Short positions can be covered once the CCI rises above –100.

The chart above shows the S&P 500 along with its CCI indicator. Notice how this indicator was on a sell signal during the September sell-off. When the S&P 500 drifted sideways from November through April, the CCI was within the +100/-100 range so no signals were fired. This helped to avoid whipsaws. There was a brief sell signal when the CCI fell below –100 in late April and then another sell in late May.

Like other indicators, it is best to use the CCI in conjunction with other technical tools. Modifications to the simple buy/sell rules can be made as well. For instance, if the CCI has fallen to –170 and you have large profits on short positions, then it may be best to lock in some of the
profits rather than waiting for the indicator to rise above –100. Money management rules are important. Still, it is easy to see the value of the Commodity Channel Index indicator.

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