Interpreting the CCI

CCI measures the difference between a security’s price change and its average price change. Strong prices are indicated by high positive readings, which demonstrate that prices are significantly above average. Low negative readings are a sign of weakness since they suggest that prices are much below their average.

The CCI can be used as a coincident or leading indicator.

As a coincident indicator. When CCI surges above +100, it reflects strong price action that can signal the start of an uptrend. When CCI plunges below -100, it reflects weak price action that can signal the start of a downtrend.
As a leading indicator. Use the CCI to identify overbought or oversold conditions that may foreshadow a mean reversion. Bullish and bearish divergences can be used to detect early momentum shifts and anticipate trend reversals.

New Trend Emerging

As previously mentioned, the majority of CCI movement takes place between -100 and +100. An prolonged move may be hinted at by a move that surpasses this range, demonstrating remarkable strength or weakness. Consider these levels to be filters that are either bullish or bearish. Technically, when the CCI is positive, it supports the bulls; when it is negative, it supports the bears. Simple zero-line crossovers, however, can produce a lot of whipsaws. Whipsaws are lessened by requiring a move above +100 for a bullish indication and a move below -100 for a bearish signal, even though entry locations will lag more.

The 20-day CCI for Caterpillar (CAT) is seen in the chart below. Over the course of seven months, there were four trend signs. Naturally, chartists should use weekly or monthly charts for long-term signals, as a 20-day CCI is not appropriate for them. On January 11, 2010, the stock reached its peak and then declined. Eight days later, on January 22, the CCI fell below -100, indicating the beginning of a longer move. On February 17, six days after the stock’s February 8 bottom, the CCI crossed above +100, indicating the beginning of a longer rally. Although CCI cannot pinpoint the precise top or bottom, it can assist in removing irrelevant movements and concentrating on the overall trend.

CCI – Chart 2

CCI triggered a bullish signal when CAT surged above 60 in June. Some traders may have considered the stock overbought and the reward-to-risk ratio unfavorable at these levels. With the bullish signal in force, the focus would have been on bullish setups with a good reward-to-risk ratio. Notice that the stock retraced around 62% of the prior advance and formed a falling flag by the end of June. The subsequent surge above the flag trend line provided another bullish signal with CCI still in bull mode.

Overbought/Oversold

Identifying overbought and oversold levels can be tricky with the Commodity Channel Index (CCI), or any other momentum oscillator for that matter. First, CCI is an unbound oscillator. Theoretically, there are no upside or downside limits. This makes an overbought or oversold assessment subjective. Second, securities can continue moving higher after an indicator becomes overbought. Likewise, securities can continue moving lower after an indicator becomes oversold.

For the Commodity Channel Index (CCI), overbought and oversold are defined differently. In a trading range, ±100 might be effective, but in other circumstances, more extreme values are required. Reaching ±200 is far more difficult and more indicative of a real extreme. The volatility of the underlying securities also influences the choice of overbought/oversold thresholds. An index ETF, like SPY, will typically have a lower CCI range than the majority of companies, like Google.

Google (GOOG) is displayed in the chart below with a CCI of 20. The advanced indicators settings were used to add horizontal lines at ±200. Google’s value surpassed ±200 at least five times between early February and early October (2010). When CCI dropped back below +200, the red dotted lines showed it, and when it moved back above -200, the green dotted lines showed it. In the event that the trend continues, it is crucial to wait for these crossings to decrease whipsaws. But such a method is not infallible. Observe how Google continued to rise even after the CCI fell below -200 and became overbought in mid-September.

CCI – Chart 3

Bullish/Bearish Divergences

Since directional momentum does not confirm price, divergences indicate a possible reversal point. When the CCI produces a higher low and the underlying asset makes a lower low, indicating less negative momentum, this is known as a bullish divergence. When the security makes a higher high and the CCI makes a lower high, indicating less upward momentum, a bearish divergence is created. Keep in mind that divergences can be deceptive during a strong trend, so don’t get overly excited about them as excellent reversal signs. Before a top truly appears, a powerful uptrend may exhibit a number of bearish divergences. On the other hand, long-term downtrends frequently exhibit bullish divergences.

The secret of divergences lies in confirmation. Chartists should establish a confirmation point for the price chart or CCI, even when divergences indicate a shift in momentum that may portend a trend reversal. A price chart support break or a CCI breach below zero can both be used to confirm a bearish divergence. On the other hand, a price chart resistance breach or a CCI break above zero might both validate a bullish divergence.

The chart below shows United Parcel Service (UPS) with 40-day CCI. A longer timeframe, 40 versus 20, was used to reduce volatility. There are three sizable divergences over a seven-month period, which is relatively few for seven months.

CCI – Chart 4

First, UPS raced to new highs in early May, but CCI failed to exceed its March high and formed a bearish divergence. A support break on the price chart and CCI move into negative territory confirm this divergence a few days later.
Second, a bullish divergence formed in early July as the stock moved to a lower low, but CCI formed a higher low. This divergence was confirmed with a CCI break into positive territory. Also notice that UPS filled the late June gap with a surge in early July.
Third, a bearish divergence formed in early September and was confirmed when CCI dipped into negative territory. Despite a CCI confirmation, price never broke support and the divergence did not result in a trend reversal. Not all divergences produce good signals.