The Commodity Channel Index (CCI) is an oscillator introduced in the 1980’s and used by many traders to pinpoint market entries. Even though its name refers to commodities, CCI can also be used to trade currencies and other markets. Traditionally CCI can be used in a variety of conditions, including breakouts, ranges and trends. Today we will primarily look at using CCI to trade trend retracements with overbought and oversold levels. So let’s begin learning about CCI!
CCI is very similar to other oscillators, such as RSI, in that it depicts overbought and oversold levels for traders. Pictured above, we can see that above the +100 value is considered overbought while below the -100 value is considered oversold. Normally 70-80% of the values tend to fall between overbought and oversold levels. As with other overbought/oversold indicators, this means that there is a large probability that the price will correct to more representative levels. Knowing this, retracement traders will wait for the indicator to stretch outside of these levels and initiate new positions from the cross back inside the range. Let’s look at an example using the NZDUSD.
(Created using FXCM’s Marketscope 2.0 charts)
Above we can see an example using a 4Hour graph of the NZDUSD currency pair. As prices decline with an established down trend in place, traders will anticipate taking new sell positions. The primary way of timing entries with CCI in a downtrend is to wait for the indicator to move above the +100 (overbought) and cross back below +100. This creates an opportunity to sell the currency as momentum is returning back in the direction of the trend. Place your stop loss just below the swing high. Look to take profits at least twice the distance to your stop loss so you are maintaining at least a 1: 2 risk to reward ratio.
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