The Commodity Channel Index (CCI), created by Donald Lambert about 35 years ago, was originally to help solve problems with engineering signals. The main use of CCI is as a momentum indictor to measure the deviation of the price from its statistical average.
The calculated CCI value is unbound and that moves above and below zero as the price changes relative to the average price. CCI values of +100 are typically considered to be overbought and values of -100 are considered as oversold.
CCI a good measure of momentum and can be used as a signal of changes in trends or swings. Generally a ‘sell signal’ occurs if stock price makes a new low below -100 and ‘buy signal’ occurs if the stock makes a new high above 100.
However, like any indicator used as a system the 'devil likes in the detail'. It is also hard to visualise what to look for on a chart when you are using the CCI indicator. Other signals and indicators are needed to use the CCI effectively.
This article describes a simple new way of using the CCI for charts called 'Buckets' which using SMA cross-overs to confirm the buy and sell signals.
Like most oscillators, the CCI was invented to determine oversold and overbought levels as signals for changes in trends and it works best in trending markets. The CCI indicator resembles the Relative Strength Index (RSI) and Williams Percent R indicators. The CCI works by tracking the relation between moving average (MA) of the price and the price itself. These deviations are calculated statistically as normal deviations from average deviation. The formula is:
The main variable to address is the time interval and the closer it is to the normal cycle or pattern of changes in prices the better it will work. Some people use multiple CCI with different time periods - say 5 and 20, or even longer. The shorter the time period the more sensitive the index will be, and the longer time will tend to filter out the noise. The default setting is 20. But experiment will various values so see what works best.
As shown in the image the areas above +100 and below -100 can be regarded accumulation areas (Buckets). Most chart applications color these areas. These are the major points:
A simple visual method is used with rules for Long and Short Entry (Buy and Sell and close points). The rules are described in the image below. The best time intervals for the SMA are 3 and 10.
For a short entry, you wait until the top bucket (or buckets) fill, to some extent and the CCI moves downward and passes through zero from above, signaling and change in trend. Wait until the change is confirmed by the cross-over of the SMAs.
For a long entry, watch until you see the bottom bucket (or buckets) fill to some extent and the CCI passes upward from below ( negative to positive values). Wait until the trend is confirmed by the SMAs cross over.
For particular stocks look back at the past data to see the pattern and trigger points. You can also use changes in cycle highs and lows for detecting divergences.
The following move precise rules seems to work in most cases.
Prices very rarely move without reversions. It is like sitting on a swing (see the image below). If you want to go higher you have to gradually swing back and forth to build the momentum force to overcome gravity. The Bulls and Bears act to want the price to move Up and Down and it may rake several swings (reversions) before the new trend is established. In a sense the buckets and their contents are simply the net accumulation of the price different from the average over a period of time. All swings will fill the buckets to some extent. However there is an extra signal from the size of the accumulation in the top and bottom buckets. The larger the volume the higher the probability that the next trend reversal will be larger and more significant. The same applies to the rate ate which the CCI score rises or falls through the zero mark. If the accumulated volumes are large and the price changes rapidly, there is a greater chance that the trend change will be larger.
The image above illustrates key features of the 'Buckets System'
A. Accumulation in the Overbought bucket during a rise with small reversions
B. After a significant accumulation the chance that the next fall of the CCI through the zero line will signal a major trend change is much higher
C. The drop in the CCI was weak and there was little accumulation in the bottom bucket (oversold region). This means that the immediate rise to oversold is weak and short-lived. The next drop continues the drop signaled at B.
D. The price rise is preceded by a two-phase accumulation.
E. After a two phase accumulation the price is primed for a drop, especially when the pin bars signal resistance.
F. Shows the multi-phase accumulation in the oversold region.
Note: A sudden dip or rise into the overbought and oversold regions with a small 'bucket' can signify the the bears or bulls are unconvinced ans the reversal may be much larger than expected. It pays to check the past patterns for a particular stock.