The Commodity Channel Index or CCI is a multiple-purpose trading tool, to be used in identifying areas of overbought or oversold zones, besides detecting emerging market trends. Although being a very powerful indicator, it does pose challenges on its own. Donald Lambert introduced the Commodity Channel Index in the year 1980 primarily to identify strong trends in commodities. However, over time, traders have adapted it into various asset classes and also timeframes.
This video discusses two major ways you can use the CCI to make your trading strategy better. We will also talk about how using it in conjunction with other technical indicators, such as the EMA and MACD, improves your win rate and the outcome of your trades.
The CCI Indicator
The CCI is an oscillating line that sits above and below a neutral zero line on a chart. This makes it look similar to the Relative Strength Index (RSI) but with a different calculation and purpose. The CCI has two horizontal lines, usually at +100 and -100, that are used as reference points to determine when the market is overbought or oversold. When the CCI moves above the +100 line, it means that the market is overbought, meaning it could be ready to reverse. However, if the CCI dips below the -100 level, it points towards an oversold market where price can easily turn in upwards.
CCI Trend Trading Strategy
The original concept behind creating CCI was for the trend identification purpose, just like what Lambert suggested. Here’s one very straightforward strategy in utilizing this tool:
Buy Signal:
The CCI going up over +100 will represent an extremely strong uptrend in its ability to have upward moves. Traders would try to enter their long position as they feel momentum turns positive.
Sell Signal:
When the CCI crosses below -100, it signals a potential downtrend, suggesting traders enter short positions to profit from falling prices.
While this method can be highly effective, caution is necessary as the CCI may produce false signals in sideways or choppy markets. To mitigate these risks, combine the CCI with other indicators like moving averages.
Enhancing with the 200-period EMA
A 200-period EMA is a good trend filter that will help in determining the prevailing direction of the market. If the price is above the 200 EMA, then the prevailing trend is bullish, and traders should only look at buy signals from the CCI. If the price is below the 200 EMA, then traders should only look at sell signals.
Risk-Reward and Win Rate
The risk-to-reward ratio should be taken into account when implementing this strategy. A higher risk-to-reward ratio, such as setting bigger profit targets, will probably lower your win rate, since the big market moves are not always consistent. A lower risk-to-reward ratio tends to increase the number of wins, but the potential profit per trade is smaller.
Before investing real capital, it is essential to test the strategy against different market conditions to confirm its workability.
CCI for Overbought and Oversold Conditions
The second strategy using CCI is the identification of overbought and oversold conditions in the market:
Overbought Signal (Sell):
When the CCI goes above +100, the market may be overbought and sell positions are recommended.
Oversold Signal (Buy):
When the CCI falls below -100, it may be an oversold condition, which indicates a buying opportunity.
This strategy is similar to the widely followed RSI trading strategy, but can be improved by combining it with the 200-period EMA so that traders will only focus on buy signals in bullish trends and sell signals in bearish trends.
Combining the MACD Indicator
The MACD indicator is very useful in confirming a momentum shift. Here is how to combine it with the CCI:
Buy Signal:
A MACD crossover below the zero line, along with a CCI buy signal, confirms upward momentum.
Sell Signal:
A MACD crossover above the zero line, when combined with a CCI sell signal, confirms downward momentum.
Combining the CCI with the MACD reduces false signals since these two will always coincide before entering into a trade.
Example for Using CCI and MACD Together
Assume the price is above the 200-period EMA, and that there is a bullish trend. The CCI creates a buy signal first. Without confirmation from the MACD, this may be a false signal. Later, CCI crosses above the lower band, while the MACD confirms also a buy signal. Now, the alignment makes the entry signal stronger, thus increasing confidence in the trade.
Conversely, if CCI indicates a sell, but MACD is not showing bearish momentum, then the trader needs to wait for further confirmation to enter the market. By this approach, traders can avoid selling on false signals and buy only when both of these indicators point toward the same direction.
High Win Rate Tips
How to Improve Your CCI Trading Strategy
- Trade along major support/resistance levels or moving averages.
- Use multiple timeframes to get a wider view of market trends and support/resistance zones.
- Validate signals with MACD to filter out false CCI signals, thus improving the accuracy of trades.
Conclusion
Used with a 200-period EMA and MACD, CCI offers a strong frame of high-probability trades. This approach protects traders from false signals while enabling alignment of their trades with the general trend of the market, thus enhancing the win rate as well as trading performance. Therefore, by focusing on aligning with the trend, risk management, and confirmed signals using multiple indicators, one enhances the success in trading greatly.
To find out more strategies and to get started with the indicators, see the download link in the video description for a template that automatically adds all the necessary indicators to your chart.