There exist a lot of tools which you can use to make your trading better. Some tools can be a help to give you signals for making entries, some show you the strength of a trend and direction or some can show you the volatility. However, when you are trading you have to be aware of extreme occurrences. You need to get warned before such thing happens.
CCI can do that: It warns you about extreme conditions and can show you new trends. Although originally developed for commodities, this indicator can also be
used for indices and currencies. The CCI helps to detect the cyclical trend of an asset’s price. It measures the links between an asset’s price, regular deviation and moving average of the
The formula to calculate CCI:
CCI = (price – Simple Moving Average of price) / (0.015 * standard deviation of price)
where price is ‘Typical Price’:
TP = (Daily High + Daily Low + Daily Close) / 3
Fore the standard deviation of price you need 3 steps. The SMA gives your mean values, hence in the first step you need to subtract each day’s mean from its ‘Typical Price’ and take only absolute values. If you are calculating e.g. 20 day CCI, you have to do this subtraction starting from 20 days prior to the current date. In the second step sum up these values and lastly divide them by the number of observations, e.g. 20. Because of the constant 0.015 most of the regular values of CCI remain between -100 and +100.
You will motice that the CCI measures the variation between an asset’s price and its average change. A higher positive CCI reading shows you that the asset is strengthening whereas lower negative CCI reading tells you the opposite.
You can use this indicator in your trades as a coincident indicator or as a leading indicator. Under the former type of application if CCI rushes above +100 it shows a very strong price action and it points towards a possible uptrend. When the CCI readings sink below -100, it reveals that the price action is weak and signals a probable downtrend. Through the prism of a leading indicator CCI can help you determine overbought and oversold conditions as well as momentum shifts.