Spotting Reversals with the Commodity Channel Index (CCI)
The Commodity Channel Index (also known as the CCI) is employed by traders in addition to other technical indicators. These can include a moving average to spot the strength of a trend, identify possible reversals in price, and those times when price exceeds historical norms. The CCI measures price momentum. It is also useful for traders interested in finding possible entry points based on overbought or oversold conditions.
An overbought condition is when the equity has had an unusually sudden move higher. Any move by the equity back down below the 100 line on the CCI indicates that it has moved too far too fast and is likely going to fall in price back to historical ranges. Conversely, any move back above the -100 line on the CCI indicates that sellers have likely been irrational and prices will likely move back up into normal territory.
About 70% to 80% of the values in the CCI are between 100 and -100 and therefore any sell signal (a move below the -100 line) or a buy signal (a move above the +100 line) only happens about 20% to 30% of the time.
Below is a bullish 15-minute chart of the EUR/USD showing the entry signals when the CCI crosses above the 100 line:
Most traders would not solely use the CCI to get out of their positions. But if they did, the rule is to get out of long positions when the CCI crosses back down through the 100 line and to get out of short positions when it crosses back up through the -100 line.
Notice that on this bullish chart, the CCI spends most of its time above the zero line. Combining the CCI with a 15-minute chart (in this case) on the EUR/USD currency pair helps a trader identify more quickly that the trend is bullish. The CCI provides good entry points in a strong trend such as this one and helps the trader stay out of trend trades that may be over.
The first five black arrows from left to right show a similar price pattern (price action trending flat right before the CCI crosses up through the 100 line showing a continuation of the bullish trend. Now look at the final (red) arrow on the right where the chart pattern looks similar to the 5 previous entry points….but the CCI is not similar.
Prudent traders combine one or more complementary technical indicators to their charts for confirmation of trends before entering their positions.