The CCI (Commodity Channel Index), which in Spanish would be something like the Raw Material Channel Index, is a very popular technical indicator developed by Donald Lambert and published for the first time in Commodities magazine in 1980.
Originally the indicator was developed to discover the big changes of long-term trends but it has been used by traders in all periods of time.
Nowadays it is an indicator that is used for all the markets of the world, not only the raw materials, but it has kept its original name.
Many people can be confused with the same thinking that it is an indicator that only works for the markets of raw materials, but nothing is further from reality, since it works almost equally with other market indicators.
First of all I want to comment on a couple of data that are very important to understand where this indicator came from and what led Lambert to develop it.
Origins of the CCI indicator
If you look closely at what I wrote you will see that Lambert’s idea was to look for “long-term” movements.
This is important to see because unlike today, the markets of 40 years ago were not so focused on day trading or extreme trading that arose with the advent of computers.
Today even a poor person in Brazil or China can negotiate, buy and sell in a matter of seconds from home and see how the price moves steadily.
Decades ago this was not the case and those who could access the markets were a minority of traders who were mostly Americans. It was, in fact, a pretty specialized market.
What people could aspire to was to try to make “quieter” trading, with operations to weeks or months.
Therefore you can be sure that the ratio of losers in trading at the time was much lower than now.
If Lambert looked for more long-term movements you can be sure that it is because those movements were, and are, the best ones for the particular traders.
The other important point of the origin of this indicator is the fact that it is related to commodities.
Because in the 70s, there was a kind of boom in the trading of these markets in the United States, especially in the form of futures.
You can be sure that at that time there were not many CFDs and of course nothing of Forex or binary options.
What was the option to negotiate leverage for US traders?
Well, nothing more and nothing less than futures.
And what were the hottest markets of those years?
Exactly, commodities, with gold, oil and almost all other raw materials in large secular markets, and with Wall Street going through some very bad years.
That is why those years developed a trading industry in the United States around the trading of commodity futures, the most fashionable and sophisticated product for trading at the time.
By putting that name Lambert was following the fashion of the moment.
Surely as other fashions are going out with the most popular markets of the moment, as it could be with Bitcoin in the second part of the decade of 2010.
How is the Commodity Channel Index calculated?
The default period that we will find in many platforms, such as MetaTrader 4, is 14.
Do not ask me why, but it is the one that is chosen as more typical; and the truth is that to use the indicator is equal to any other number, believe me, in the end there will be no big difference between choosing 14, 18 or 24.
CCI = (Typical price – Simple Moving Average of x periods (14 in this case) / (0.015 * Mean Deviation).
The typical price would be the kind of medium price of a bar. That is, it would be the sum of the maximum, minimum and closing price and divide the result by three.
The denominator part is formed by 0.015, which is the number chosen by Lambert to make sure that most of the values of the indicator fall between +100 and -100 which would be the two extremes that the graph of the same gives us, which, obviously, is essential to understand why we have to sell when we sell and vice versa when we buy.
The average deviation results from calculating the typical average of the 14 most recent typical price periods. Then the absolute value of them is calculated and all are added. At the end it is divided by the number of periods chosen in the case studied (14).
How does the CCI indicator work?
This indicator appears below the graph and shows us a range that oscillates above and below zero.
This range is the one set by the values +100 and -100.
The example we have there belongs to a daily oil chart with a period of 40 units to try to have less “signs” of trading, for about three years, from 2015 to 2018.
Here we are not seeing the price but we do see the oscillations of the indicator.
Seeing this chart where do you think it would be best to sell or buy?
You can see that you can apply a large number of strategies.
For example, you can buy with the indicator exceeding the value of +100, or when it exceeds 0, or +50. You can do the reverse, and sell when you get off -100 or 0 or -30.
The opportunities and possibilities are endless as you can see.
Strategies to trade with the CCI
Buy strategy above +100
This is one of the typical strategies of this indicator and means that each time the CCI is above 100 or below, we will have a buy or sell signal respectively.
Well, because it is a fairly clear trend strategy, which seeks to operate with market forces and looking for a clear upward or downward movement.
Does this strategy work?
As you can see in the chart, we are going to have a lot of buying and selling signals over 3 years. Up to no less than 20 and the same to sell.
Surely at first sight we can hope and think that it will be a wonderful system that will give us many winning and losing trades.
The sad reality is that this is not the case, and with such a simple strategy – not because the simple is bad – we will not be able to dominate the markets so easily.
The problem of this strategy can be seen clearly when we look at the entire chart, with the CCI and with the typical price bars.
In this case we see how oil has had a bear market at the beginning, another bullish market later, followed by a lateral one of at least a year and ending with a bullish one.
The bearish signals of this indicator worked quite well in the bearish phase, but in the lateral phase and above all the bullish one, we can see how the indicator behaved disastrously (red lines).
The same can be said for the blue lines, which is when the indicator had the purchase signals. We can also see how many of those that occurred in the bearish and lateral phase – which were not few by the way – were quite bad.
On the other hand, we have to take into account the other no less important variable of the equation:
What are our target price and our loss limit?
As we choose one or the other, we are going to have a very big change in our trading results.
What is the problem that I see with this strategy?
Well, it tends to give us too many signals. This, however, is what many traders or aspiring traders like, who believe that the greater the greater the possibility of profit.
If we apply the 14 periods, a number closer to what many traders choose, we see that the number of buy or sell signals could be even higher. This, obviously, is not in our favour.
Solution to have fewer signals?
Choose longer periods, which in the end are the most reliable.
Those longer periods give you better signals when there is a large bull market or bearish, as in the case of oil, like the one that gave us in 2014 using a period of 240.
Do you think that the ideal thing there was to look for a 5% profit?
As you see, no.
However, do not think that this is so easy, because if we go to the previous years, with a long and fucked-up side market and in which having tried to apply this strategy with 240 periods, it would not have been a good idea either.
Once again, we come across the big problems of the markets, and it turns out that what is going well for a bullish or bear market is going very badly for a lateral one.
The problem with the stock market is that the side markets are more common than it seems.
What is the solution to this?
Maybe you will say: “the solution, then, is to negotiate the opposite, that is, buy when you are in -100 and sell when you touch +100”.
But I already tell you that you will encounter the same problem as before, and you will have good gusts with side markets and bad gusts with bullish or bearish markets.
And what happens if we want to do day trading with this indicator?
One more thing: you will not be the only one who is applying it.
Remember that there are tens of millions of traders in the world, and it is very likely that a couple of dozens of thousands, at least, are using variables from this indicator.
In the day trading is where you try harder to apply the CCI.
Unfortunately, the problem I mentioned earlier with respect to the side and trend markets also applies to the short term.
Do not think that by trying to negotiate in the graphs of a couple of days you will not find side or trend markets. You will always end up finding both, and depending on your strategy, a system will work better for you and worse for another.
Unfortunately, I can tell you that you will hardly find a strategy that using this single indicator will catapult you into the Olympus of trading and become an independent and professional trader.
Things do not work like that unfortunately.
I think it is not a bad indicator at all, and certainly better and easier to intuit and understand than others. In fact, if we rely on it, it remains fairly close to the market price, so negotiating it is similar to following market trends.
I recommend that before you use it blindly you study it very deeply, if it can be applying as many temporalities as possible, if possible with automated backtesting options.
But above all, and this is very important, you should look for the best way to use the indicator to give you great benefits when you are right and small losses when you are not. That is, one of the keys if you want to succeed in it is: “let the benefits run” and “cut the losses.” Applying these two axioms of trading is imperative if we want to have a minimal chance of long-term success, whether using the CCI indicator or any other.
Oh, and as always, do not forget to apply good money management.
Greetings and good trading
Original artcile: ¿Es el indicador CCI un buen indicador?