How to Use the Commodities Channel Index
The Commodity Channel Index is one of the most controversial oscillators used to forecast price movements. It was developed in the 1980s and, despite the name suggesting a commodity indicator, it is widely used on the Forex market as well, and Forex brokers offer it under the Indicators tab. Being an oscillator, it means that it is applied on the lower section of the screen, below the actual chart. Like any oscillator, it plots a value based on different periods back in time, and traders use it to correctly spot reversals, or the beginning of a new trend. Oscillators are offered by the MetaTrader4 platform under the Indicators tab. The Commodity Channel Index is the default setting, which tells us much about the popularity of this indicator.
As you can see on the figure above, there are many oscillators that populate that list, and traders can even create new ones and import them as well. However, in the end, all oscillators are designed to show the same thing: any fake moves the price is making.
As a rule of thumb, traders should always stay with the oscillator and not with the current price a currency pair is showing, as the oscillator is built to take into account a longer period.
Before plotting the CCI below a chart, one can choose the parameters the oscillator will consider, such as the period back in time. In this case, the standard period is the 14, meaning the CCI will take into consideration the values of the last 14 candles. If the oscillator is attached to a monthly chart, then the values of the last 14 months will be considered before plotting it. This value can be modified based on the trader’s preference, and it should be taken into account that the CCI will flatten more the longer the period is. Such an outcome is valid for all oscillators that have a longer period, or more candles, taken into account. If we leave the 14 periods for the CCI oscillator and click the OK button, the oscillator will be plotted, and the chart will look like the image below.
Trading with the CCI
Before showing concrete strategies to trade with the CCI oscillator, a closer look at the indicator is needed. As you can see, by default, there are three levels that appear: –100, 0, and +100. It means that the Commodity Channel Index travels into negative territory as well, and the zero level probably has some impact on trading too. Let’s see what the three ways to use the CCI in order to find good and profitable trades are:
Bullish and Bearish Divergences
One way to use the CCI is to look for bullish and bearish divergences between the actual price and the oscillator. Such divergences are a great signal for trend reversals, and are widely used by traders. It is said that a divergence is forming when the price and the oscillator are showing two different things. A bullish divergence means that the price makes two consecutive lower lows, while the oscillator does not confirm the second low. A bearish divergence, on the other hand, forms when the price makes two consecutive higher highs and the oscillator does not confirm the second one. Given the fact that the oscillator takes into account more candles (in this case 14 candles, as 14 is the period chosen before plotting the oscillator), traders should always stay with the oscillator. This means that when a bullish or a bearish divergence is forming, eyes should stay on what the oscillator is showing rather than on what the price is doing.
The chart above shows a classical bearish divergence price forming with the CCI and, again, traders should stay with the oscillator. By the time the price forms the second higher high, the oscillator is not confirming it, and the second spike is actually lower. This is the very definition of a bearish divergence. A bullish divergence will show exactly the same thing, only that the signal is a buying one.
Trading Overbought and Oversold Levels with the CCI Oscillator
Another way to trade with the CCI is to look for overbought and oversold levels and to take a trade in the opposite direction. However, we cannot consider the –100 and 100 levels as being oversold or overbought, as a quick look at those levels shows us that the price is travelling way beyond them. The risk, therefore, is to be trapped in a wrong trade as the overbought and oversold areas are simply not defined properly. In order to do that, we need to right-click on the chart, choose the Indicators List tab, and edit the levels on the Commodity Channel Index oscillator. As you can see on the chart below, the newly added levels are –250 and +250. The idea is to sell any move above +250 and buy any move the price makes below –250, as these levels are closer to what overbought and oversold areas mean. However, you can use whatever levels you feel work better at identifying these kind of areas.
The example above shows us four entries on the short side, while the price is only moving in a bullish trend. It means that using this strategy will suit scalpers more than swing traders. However, applied on a longer timeframe, it will be sufficient for swing traders to profit as well.
Trading the Zero Level
Last but not least, traders use the CCI to trade short- to very-short-term positions. This means that this approach is dedicated exclusively to scalpers, and it first needs a trend to be defined. The trend can be identified using a trend indicator or a divergence, but once in place, the idea is to buy when the CCI travels above the zero level from a negative territory, or to sell when the CCI moves below the zero level from the positive territory. The zero level can be added in the same way as we added the levels in the previous example. No matter how the CCI is used, it is favoured by traders because its swings can have multiple interpretations. It depends on the traders, and them only, to properly use this oscillator and to find the right trading style to benefit most from the CCI swings.
Other educational materials
- Trading with the Cloud – Use Ichimoku Cloud to Spot Reversals
- Trading Forex with the Kijun/Tenkan Cross
- Technical Analysis – What to Consider
- Moving Averages – Find Support and Resistance Areas
- Forex Trading Accounts and the Value of a Pip
- The Importance of Swap and Spreads
Recommended further readings
- Commodity index investing and commodity futures prices. Stoll, H. R., & Whaley, R. E. (2010). Journal of Applied Finance (Formerly Financial Practice and Education), 20(1).
- Index funds, financialization, and commodity futures markets. Irwin, S.H. and Sanders, D.R., 2011. Applied Economic Perspectives and Policy, p.ppq032.