How 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 timeframes. Below we discuss the strategies that both investors and traders can employ.

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%, will fall between -100 and +100, about 25% of the values will fall outside this range, indicating a lot of weakness or strength in the price movement.

Figure 1. Stock Chart with CCI Indicator

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 time frame 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 will provide 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.

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 wish 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 2011 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 2012 a buy signal was triggered, and the long position stays open until the CCI moves below -100.

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. A multiple timeframe strategy is commonly used by more active traders and 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 2012. 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.

When it comes to using CCI, you can 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 time frame when the longer-term CCI is above +100. This will reduce the number of signals, but will ensure the overall trend is very 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 wish 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 CCI can be used across any markets or timeframes. Trading with multiple timeframes will provide 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 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.