The CCI, when used in conjunction with other oscillators, can be a valuable tool to identify potential peaks and valleys in the asset's price, and thus provide investors with reasonable evidence to estimate changes in the direction of price movement of the asset.
Understanding the CCI Like most oscillators, the CCI was developed to determine overbought andoversold levels. The CCI does this by measuring the relation between price and a moving average(MA), or, more specifically, normal deviations from that average. The actual CCI calculation, shown below, illustrates how this measurement is made.
- Open up the stock's yearly chart.
- Locate two highs or two lows on the chart.
- Take note of the time interval between these two highs or lows (cycle length).
- Divide that time interval by three to get the optimal time interval to use in the calculation (1/3 of the cycle).
|Figure 1: Chart courtesy of StockCharts.com|
Here we can see that one cycle (from low to low) starts at Oct 6 and finishes on Aug 9. This represents roughly 225 trading days, which, divided by three, gives a time interval of about 75.
Applying the CCI Since it was invented, the CCI calculation has been added as an indicator to many charting applications, eliminating the need (thankfully) to do the calculations manually. Most of these charting applications simply require you to input the time interval that you would like to use. Figure 2 shows a default CCI chart for SUNW:
|Figure 2: Chart courtesy of StockCharts.com|
Note that the CCI actually looks just like any other oscillator, and it is used in much the same way. (To learn more about oscillators, see Getting to Know Oscillators.) Here are the basic rules for interpreting the CCI:
Possible sell signals:
- The CCI crosses above 100 and has started to curve downwards.
- There is bearish divergence between the CCI and the actual price movement, characterized by downward movement in the CCI while the price of the asset continues to move higher or moves sideways.
- The CCI crosses below -100 and has started to curve upwards.
- There is a bullish divergence between the CCI and the actual price movement, characterized by upward movement in the CCI while the price of the asset continues to move downward or sidesways.
Figure 3: Chart courtesy of StockCharts.com
The red arrows show turning points that emit sell signals, while the green arrow shows a turning point emitting buy signals. The short blue lines, indicating the impending trends, show the divergence between the CCI and price.
Always Get Confirmation It is extremely important - as with many trading tools - to use the CCI with other indicators. Pivot points work well with the CCI because both methods attempt to find turning points. Some traders also add moving averages into the mix. In Figure 3 above, you can see that the 60-day exponential moving average (violet horizontal line) provides a good support level; however, determining which MA level is best varies by stock
Another possible supplement to the CCI is the use of candlestick patterns, which can help confirm exact tops and bottoms throughout the CCI's "selling period" (time in which it is above 100) or "buying period" (time in which it is below -100).
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