The idea that markets move in a cyclic manner is hardly new, and is the basis of several general theories. The Commodity Channel Index (CCI) is an attempt to model these cycles themselves.

As originally formulated, the recommended base parameter is 1/3 of the total cycle length. Therefore if the cycle runs 60 days (a high arriving approximately every 60 days), then a 20-day CCI would be suggested. (But then, I hear you ask, how is the cycle is determined? Which we’ll leave for now, and come back to when time permits…).

Calculation of CCI

1. The previous period’s Typical Price TP = (H+L+C)/3
where H = high, L = low, and C = close.

2. Calculate the 20-period Simple Moving Average of the Typical Price (SMA).

3. Calculate the Mean Deviation (MD). First, calculate the (absolute) value of the difference between the previous period’s SMA and the TP for each of the past 20 periods. Add all of these together and divide by 20.

The CCI is then obtained using this formula:

CCI = Typical Price – SMA / 0 .015 x MD

The scaling constant 0.015 is chosen almost entirely to ensure that 70-80% of values fall between + or – 100

Signals
Movements above +100 and below -100 can be taken as buy and sell signals.
Reversals – overbought / oversold levels. Oversold, when the CCI goes below -100 and overbought when it goes above +100. Therefore, for example, a buy signal might be given when the CCI moves back above -100, and a sell signal vice-versa.

Here’s a real-life chart with a 20-period CCI plotted -

I’m not so convinced that this has any place in forex trading – as a momentum oscillator, there are other indicators a lot more suited to the particular job, not least MACD. And to be fair, no great claims are made for it, but if you’ve seen it on your MT4 and ever wondered…