Wednesday, March 10, 2010

CCI-3

I  chose to write on CCI-3 thanks to a reader request which was the latest comment on the blog. So it is really a case of last request accepted.
The CCI stands for Commodity Channel Index. The term 'channel' in the name could be misleading, since the indicator does not actually create a channel, it plots a single line. Also, it is not exactly an 'Index' and it is suitable for all security types - stocks, futures, commodities, therefore it is not directly related to commodities. So much for the name.


The CCI is a momentum indicator. Momentum measures the rate of change in prices. If prices are furiously moving up, then momentum moves up with prices. If prices are moving up although at a slow pace, momentum will slow down, and, in most cases actually start falling. The fall reflects the slower increase in price.


Donald Lambert the developer of CCI suggested using a 20 period lookback to calculate the indicator. The CCI oscillates around a zero line, but it is not a bounded indicator. It is not restricted to values between 0 and 100. Lambart suggests using +100 as the resistance level and -100 as the support level.


The CCI can be used in many ways:


•CCI can be used to identify overbought and oversold levels. A security would be deemed oversold when the CCI dips below -100 and overbought when it exceeds +100. From oversold levels, a buy signal might be given when the CCI moves back above -100. From overbought levels, a sell signal might be given when the CCI moved back below +100.




•As with most oscillators, divergences can also be applied to increase the robustness of signals. A positive divergence below -100 would increase the robustness of a signal based on a move back above -100. A negative divergence above +100 would increase the robustness of a signal based on a move back below +100.


•Trend line breaks can be used to generate signals. Trend lines can be drawn connecting the peaks and troughs. From oversold levels, an advance above -100 and trend line breakout could be considered bullish. From overbought levels, a decline below +100 and a trend line break could be considered bearish.
 
•The CCI can also be used as a Trend Indicator. A move above +100 can be considered as the start of an uptrend. The uptrend remains intact so far the CCI remains above +100. A move below -100 can be considered as the start of a downtrend. The downtrend remains intact so far the CCI remains below -100.
 
AmitKBaid1008 wrote "Last two posts from you were much educating ones. I would like to know about using CCI(3) for identification of pullbacks"
 
When the default value of 20 as lookback is changed to 3, the indicator will quickly move from +100 to -100. Even a slight pause in prices will bring the indicator down to -100. The purpose of CCI-3 is to identify quick pullbacks where an uptrending stock dips / pauses for a few days and its CCI-3 falls to -100 or lower. A decline to -100 suggests that the short term dip is likely to be over. The reverse is true for downtrending stocks where a rally above +100 will tell the trader that a short rally is likely to be over and the original trend (down) will assert itself.
 
The CCI-3 should be used only where the trend of the stock is clear, only with strongly trending stocks.


Its use on intraday charts is limited, since there will be a lot of noise, causing whipsaws. Ideally, it should be use on the daily time frame.


Once the CCI-3 dips below -100 (in an uptrend), the question of trading tactics comes up. The dip in the CCI is an indication of an oversold condition, but prices may still go down before a reversal. A stop loss can be triggered at the worst possible location. This problem can be resolved by buying above the high of the latest bar, and, installing a stop below the low of the dip. Often, a dip in the CCI-3 is immediately followed by a big range day. Buying above the high could mean missing such moves, and, actually ending up at the top of a short term trend. That's a pity but the trader does not have to trade. If the CCI-3 is immediately followed by a big range day, then the trader can step aside. Sometimes, he may be lucky enough to spot such trades intra day , since he already has a short list of stocks where such moves could be expected.


Once inside a trade, look to exit on any Range Expansion (a big move in your favor) or when the CCI-3 goes above +100, or in a specific time , example: exit on the open of the third day, assuming the earlier two exits have not been trigggered.
Your feedback will be appreciated, since I have explained the concept as I understand it, maybe missing some critical elements of the strategy.


Cheers.

2 comments:

rajamani said...

Hi Sudharshanji, kindly add google search in the blog so readers can search your older posts.regards-rajamani

gourv said...

Hello sir,
Gourav here.we can use CCI(20) as directional index to determine the trend and CCI(3) as oscillator for timing entry.Sir there are many similar indicator for the same purpose like ADX/DMI,CCI(2O),MACD as directional indicator and STOCKASTICS,RSI,W%R,MOMENTUM etc for
timing/oscillator..so is it fine if we use only 1 indicator out of each set.I would really like to know which indicators you use.
Hoping to get an elaboration on this.

Regards
Gourav