3. Calculate the mean deviation over ‘n’ periods
Mean Deviation = (| MA last – Avg Px 1 | + | MA last – Avg Px 2 | + … + | MA last – Avg Px n|) / n

4. CCI = (Average Price – MA) / (0.015 * Mean Deviation)

The Commodity Channel Index is an oscillator style indicator, created by Donald Lambert. It oscillates between an overbought and oversold condition that works best in a sideways market. It does not work well in trending markets and it’s therefore recommended that it be used in conjunction with another, more directional indicator. An indicator such as the DMI (ADX) can eliminate those disastrous times when you are issued with a signal to sell an overbought market in a bull market trend.

Lambert recommended using about 1/3 of the markets obvious cycle as the best parameter for calculating the CCI. If the natural cycle of the market were 90 days then a period of n = 30 would be used in the above calculations and added to a daily chart, usually along the bottom of the chart.

The CCI is essentially measuring how far is price away from the moving average and how fast it moved to get there. If price is right at the moving average, the CCI will be 0. The constant (0.015) tends to restrict 80% of the scores to within <+100 and >-100. Even though the indicator has no boundaries theoretically, +200 or –100 would be considered extreme. The indicator is considered to be reflecting an overbought condition at +100 or above and an oversold condition at –100 or below. These levels are indicated on the chart below by a red and blue line.

How to use the Commodity Channel Index

There are numerous ways to use the index, but two are obvious. The first is as a straight buy and sell indicator. When the indicator is above +100 and the market is overbought, look for selling opportunities and when it’s oversold, with the indicator below –100, look for buying opportunities. The second is as a divergence indicator. If price makes a new high and the indicator fails to make a new high then a price reversal is often indicated.

It is strongly recommended that this indicator be used in conjunction with a directional indicator, to negate the signal if the market is trending against the signal. Conversely it’s a boost if you get a signal to buy the market in a bull trend or to sell the market in a bear trend.

There are many other ways to use this indicator. It can be used to confirm a break out from a recent trading range as it measures the speed at which the market is accelerating away from its moving average.

In the example below, you can see that the underlying trend is up and therefore when the indicator has risen above +100 it has not really generated a profitable sell signal. However when the indicator dropped below –100 it generated a successful and profitable buy signal.

It’s subtle, but you can also see the acceleration of the index, in both directions, which can then be associated with price movement outside a recent trading range.