The Commodity Channel Index or CCI is a technical analysis indicator used by traders to look for unusual price activity to help identify when a commodity is overbought or oversold.
It was originally developed in 1980 by Donald Lambert for commodity trading but its use has now grown to include equities, currencies and futures. It is a common feature on many trading platforms.
The CCI index was developed by Lambert as a way of finding the optimal time to enter seasonal commodities markets. Calculating the CCI is complicated, involving use of a moving average, a mean deviation and Lambert’s standard devisor. Fortunately, trading platforms will do the number crunching for you these days.
For the mathematicians among you, the sums look like this:
CCI = (Typical price - 20-period SMA of TP) / (.015 x Mean Deviation)
The typical price (TP) is the mean of the high, low and close price: (High + Low + Close)/3
Lambert set the constant at .015 to ensure that approximately 70% to 80% of CCI values would fall between -100 and +100.
There are four steps to calculating the Mean Deviation:
1. subtract the most recent 20-period average of the typical price from each period's typical price
2. take the absolute values of these numbers
3. total the absolute values
4. divide by the total number of periods (20).
As we said before, most trading platforms do the sums for you.
The CCI is an unbounded oscillator, which means that its values have no top and bottom limits but Lambert’s devisor ensures that the majority of calculations will be in the -100 to +100 range. Lines are normally drawn at the positive and negative 100 points as boundary indicators.
These markers indicate the beginning of the oversold and overbought areas but different markets will have different extremes, with ETFs, for example, tending to reach less extreme values than shares, which can easily get to 200 on the CCI. The parameters of the CCI can be adjusted to take into consideration the behaviour of the asset, with more volatility leading to higher values.
The number of periods used for calculation of the Commodity Channel Index can also vary, with 20, 30 or 40 being common. A period can be anything from one minute upwards. Shorter periods will give more signals.
Two timeframes can also be used together on a CCI chart to examine a trend using a long-term chart and opportunities to buy and sell within that trend using a short-term one.