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How Traders Use CCI (Commodity Channel Index) to Trade Stock Trends
How Do Traders Use CCI (Commodity Channel Index) to Trade Stock Trends?
The CCI, or Commodity Channel Index, was developed by Donald Lambert, a technical analyst who originally published the indicator in Commodities magazine (now Futures) in 1980. Despite its name, the CCI can be used in any market and is not just for commodities.
CCI is calculated with the following formula:
(Typical Price – Simple Moving Average) / (0.015 x Mean Deviation)
The CCI was originally developed to spot long-term trend changes but has been adapted by traders for use on all markets or timeframes. Trading with multiple timeframes provides more buy or sell signals for active traders. Traders often use the CCI on the longer-term chart to establish the dominant trend and on the shorter-term chart to isolate pullbacks and generate trade signals.
- The CCI is a market indicator used to track market movements that may indicate buying or selling.
- The CCI compares current price to average price over a specific time period.
- Different strategies can use the CCI in different ways, including using it across multiple timeframes to establish dominant trends, pullbacks, or entry points into that trend.
- Some trading strategies based on CCI can produce multiple false signals or losing trades when conditions turn choppy.
The strategies and indicators are not without pitfalls, and adjusting strategy criteria and the indicator period may provide better performance. Although all systems are susceptible to losing trades, implementing a stop-loss strategy can help cap risk, and testing the CCI strategy for profitability on your market and timeframe is a worthy first step before initiating trades.
Understanding How Traders Use CCI (Commodity Channel Index) to Trade Stock Trends
The CCI compares the current price to an average price over a period of time. The indicator fluctuates above or below zero, moving into positive or negative territory. While most values, approximately 75%, fall between -100 and +100, about 25% of the values fall outside this range, indicating a lot of weakness or strength in the price movement.
Figure 1. Stock Chart with CCI Indicator
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The chart above uses 30 periods in the CCI calculation; since the chart is a monthly chart, each new calculation is based on the most recent 30 months. CCIs of 20 and 40 periods are also common.
A period refers to the number of price bars the indicator will include in its calculation. The price bars can be one-minute, five-minute, daily, weekly, monthly, or any timeframe you have accessible on your charts.
The longer the period chosen (the more bars in the calculation), the less often the indicator will move outside -100 or +100. Short-term traders prefer a shorter period (fewer price bars in the calculation) since it provides more signals, while longer-term traders and investors prefer a longer period such as 30 or 40. Using a daily or weekly chart is recommended for long-term traders, while short-term traders can apply the indicator to an hourly chart or even a one-minute chart.
Indicator calculations are performed automatically by charting software or a trading platform; you’re only required to input the number of periods you wish to use and choose a timeframe for your chart (i.e., 4-hour, daily, weekly). Stockcharts.com, Freestockcharts.com, and trading platforms such as Thinkorswim and MetaTrader all provide the CCI indicator.
When the CCI is above +100, this means the price is well above the average price as measured by the indicator. When the indicator is below -100, the price is well below the average price.
CCI Basic Strategy
A basic CCI strategy is used to track the CCI for movement above +100, which generates buy signals, and movements below -100, which generates sell or short trade signals. Investors may only want to take the buy signals, exit when the sell signals occur, and then re-invest when the buy signal occurs again.
Figure 2. ETF Chart with CCI Basic Trade Signals
The weekly chart above generated a sell signal in 2020 when the CCI dipped below -100. This would have told longer-term traders that a potential downtrend was underway. More active traders could have also used this as a short-sale signal. This chart demonstrates how in early 2020 a buy signal was triggered, and the long position stays open until the CCI moves below -100.
Multiple Timeframe CCI Strategy
The CCI can also be used on multiple timeframes. A long-term chart is used to establish the dominant trend, while a short-term chart establishing pullbacks and entry points into that trend. More active traders commonly use a multiple timeframe strategy, and one can even be used for day trading, as the “long term” and “short term” is relative to how long a trader wants their positions to last.
When the CCI moves above +100 on your longer-term chart, this indicates an upward trend, and you only watch for buy signals on the shorter-term chart. The trend is considered up until the longer-term CCI dips below -100.
Figure 2 shows a weekly uptrend since early 2020. If this is your longer-term chart, you will only take buy signals on the shorter-term chart.
When using a daily chart as the shorter timeframe, traders often buy when the CCI dips below -100 and then rallies back above -100. It would then be prudent to exit the trade once the CCI moves above +100 and then drops back below +100. Alternatively, if the trend on the longer-term CCI turns down, that indicates a sell signal to exit all long positions.
Figure 3. Buy Signals and Exits in Longer-term Uptrend
Figure 3 shows three buy signals on the daily chart and two sell signals. No short trades are initiated, since the CCI on the long-term chart shows an uptrend.
When the CCI is below -100 on the longer-term chart, only take short sale signals on the shorter-term chart. The downtrend is in effect until the longer-term CCI rallies above +100. The chart indicates that you should take a short trade when the CCI rallies above +100 and then drops back below +100 on the shorter-term chart. Traders would then exit the short trade once the CCI moves below -100 and then rallies back above -100. Alternatively, if the trend on the longer-term CCI turns up, exit all short positions.
Alterations and Pitfalls of CCI Strategies
You can use CCI to adjust the strategy rules to make the strategy more stringent or lenient. For example, when using multiple timeframes, make the strategy more stringent by only taking long positions on the shorter timeframe when the longer-term CCI is above +100. This reduces the number of signals but ensures the overall trend is strong.
Entry and exit rules on the shorter timeframe can also be adjusted. For example, if the longer-term trend is up, you may allow the CCI on the shorter-term chart to dip below -100 and then rally back above zero (instead of -100) before buying. This will likely result in a paying a higher price but offers more assurance that the short-term pullback is over and the longer-term trend is resuming.
With the exit, you may want to allow the price to rally above +100 and then dip below zero (instead of +100) before closing the long position. While this could mean holding through some small pullbacks, it may increase profits during a very strong trend.
The figures above use a weekly long-term and daily short-term chart. Other combinations can be used to suit your needs, such as a daily and hourly chart or a 15-minute and one-minute chart. If you’re getting too many or too few trade signals, adjust the period of the CCI to see if this corrects the issue.
Unfortunately, the strategy is likely to produce multiple false signals or losing trades when conditions turn choppy. It is quite possible that the CCI may fluctuate across a signal level, resulting in losses or unclear short-term direction. In such cases, trust the first signal as long as the longer-term chart confirms your entry direction.
The strategy does not include a stop-loss, although it is recommended to have a built-in cap on risk to a certain extent. When buying, a stop-loss can be placed below the recent swing low; when shorting, a stop-loss can be placed above the recent swing high.
The Most Important Technical Indicators For Binary Options
Consider the following bets:
- Pay $45 to bet gold will be above $1,700 at 1:30 p.m. today. Get $100 ($55 profit) if you win, lose $45 otherwise.
- Receive $81 now to bet that the NASDAQ 100 will go below 8600 points at 2 p.m. today. Keep a profit of $81 if your prediction comes true. If it does not, lose $19.
- Pay $77 to win $100 if the USD-JPY forex rate goes above 108 at 3 p.m. today; you lose $77 if it does not.
Welcome to binary options. All or nothing, one or zero, these securities are available on Nadex. Binary options allow traders to make time-bound conditional bets on predefined values of stock indices, forex, commodities and events. Like a standard exchange-traded option, each binary option has an option premium ($45, $81 and $77 in the examples above), a pre-determined strike price ($1,700, 8600 points and 108 yen), and an expiry (1:30 p.m., 2 p.m., 3 p.m. today).
The differentiator is the settlement price that remains fixed at $0 or $100, depending on the option condition being fulfilled. It keeps the net profit (or loss) fixed. The option premium also remains between $0 and $100. (Related: Guide to trading binary options)
Since binary options are time-bound and condition-based, probability calculations play an important part in valuing these options. It all boils down to “What is the probability that the current gold price of $1,220 will move to $1,250 or above in the next four hours?” The determining factors include:
- Volatility (how much and is it sufficient to cross the threshold/strike price?)
- The direction of the price move
Technical indicators suitable for binary options trading should incorporate the above factors. One can take a binary option position based on spotting continued momentum or trend reversal patterns. Let’s look at some of the popular binary option technical indicators:
- Wilder’s Directional Movement Indicators (DMI) Average Directional Index (ADX): Composed of three lines, namely ADX, DI+, and DI-, and their relative positions, this indicator aims to capture the strength of an already identified trend. Here is the table for interpreting the trends:
ADX Value > 25
Here is an illustration, using 3M Company (MMM) stock:
Image courtesy StockCharts.com
Depending upon the identified momentum and trend strength, an appropriate buy/sell position could be taken.
- Pivot Point(in conjunction with support and resistance levels): Pivot point analysis helps determine trends and directions for any given timeframe. Because of the flexibility in timing, pivot points can be used for binary options, particularly for trading highly liquid major currencies. A good example (with calculation and graphs) is included in the article Using Pivot Points in Forex Trading.
- Commodity Channel Index (CCI): The CCI calculates the current price level of a security relative to the average price during any given timeframe. The average price level is usually the moving average. Time periods can be selected as desired, allowing the trader flexibility in choosing when a binary option expires. The CCI is useful in identifying new trends and extreme conditions of overbought/oversold securities. It is very popular among day traders for short-term trading and may be used with additional indicators such as oscillators. In the below formula “price” is the asset’s current price, “MA” is the moving average of the asset’s price, and “D” is the normal deviation from that average. High values above +100 indicate the start of a strong uptrend. Values below -100 indicate the start of a strong downtrend. The CCI is computed with the formula:
- Stochastic Oscillator: In an interview, the creator of the Stochastic Oscillator, Dr. George Lane, said “it follows the speed or the momentum of price. As a rule, the momentum changes direction before price.” This important underlying detail indicates extreme cases of overbuying and overselling, allowing reversals for bullish and bearish phases to be identified. The crossover of %K and %D values indicate trade entry signals. Although a 14-day period is standard, binary option traders can use their own desired timeframes.
%K = 1 0 0 ( C − L14 H14 − L14 ) where: C = most recent closing price L14 = low of 14 previous trading sessions H14 = highest price traded during same 14-day period \begin
Levels above 80 indicate overbought, while those below 20 indicate oversold.
- Bollinger Bands: Bollinger bands capture an important aspect of volatility. They identify upper and lower levels as dynamically generated bands based on recent price moves of a security.
Commonly followed values are 12 for simple moving average and two for a standard deviation for top and bottom bands.
Contraction and expansion of the bands indicate reversal signals that help traders take appropriate positions in binary options. Overbought situations are indicated if the current market price is above the top band. While overselling is indicated when the current market price is lower than the lower band.
A challenge in binary option trading is correctly predicting the sustainability of a trend over a given period. For example, a trader may take the right position for an index, predicting it would hit 1250 at the end of a five-hour period, but the level was achieved in the first two hours. Constant monitoring is needed for the rest of the three hours if the trader plans to hold the position until expiry, or a predetermined strategy should be executed (like squaring off the position) once the level is reached.
The Bottom Line:
The technical indicators discussed above should be used for timely actions with constant monitoring. One major disadvantage with technical indicators is that the results and calculations are based on past data and can generate false signals. Traders should practice caution with detailed backtesting and thorough analysis for high-risk, high-return assets like binary options.
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