The Commodity Channel Index developed by Donald Lambert is designed to identify cyclical turns in price. It is a momentum indicator, which measures the position of price in relation to its moving average. This signals when the market is overbought/oversold or when a trend is weakening.
If we combine the characteristics of the CCI indicator along with the Reversal Bar candlestick to form a little trading method,gives us good results.
First let us look at the basics of these two indicators to help us understand why we should combine them.
CCI
It is represented by a single line, which oscillates between fixed ranges of +200 to -200. In its basic form it can be used in 2 ways –
1. As an overbought/oversold indicator. When the CCI moves above +100, it indicates a strong uptrend and the +200 value would determine the overbought area. Price would be expected to turn down from around the +200 range and a sell order could be placed once it crosses the +100 level down.
2. To determine divergences from the price trend.
Reversal Bars
These are single candlestick patterns, which are very effective. In the example below I have used a daily chart but these parameters could apply to any time frame.
For an Up Reversal Bar (reverse the rules for a down Reversal Bar) -
• Reversal Bars work best in a developed trend – If a trend has been going for some time, then it is reasonable to wonder when it is going to end. The reversal bar can help. If a trend has previously been down, then the reversal bar (bar #2) should make a lower low.
• Close should be greater than the previous close: Not only should the price reverse back up, but it should do so convincingly.
• Close should be greater than the open: At the end of the day there is more interest in buying the market than selling it.
Ideally one should place a buy order above the high of the Reversal Bar and the stop below the low of the bar (for an up reversal bar). This would help take care of volatile spikes occurring in the next few bars.
In cases where a reversal bar might be a beginning of a retracement, rather than a change in trend the CCI can be a very good filter. With retracements the CCI generally doesn’t reach oversold/overbought areas and would warn us that the reversal bar does not mean a change in trend.
If we combine the characteristics of the CCI indicator along with the Reversal Bar candlestick to form a little trading method,gives us good results.
First let us look at the basics of these two indicators to help us understand why we should combine them.
CCI
It is represented by a single line, which oscillates between fixed ranges of +200 to -200. In its basic form it can be used in 2 ways –
1. As an overbought/oversold indicator. When the CCI moves above +100, it indicates a strong uptrend and the +200 value would determine the overbought area. Price would be expected to turn down from around the +200 range and a sell order could be placed once it crosses the +100 level down.
2. To determine divergences from the price trend.
Reversal Bars
These are single candlestick patterns, which are very effective. In the example below I have used a daily chart but these parameters could apply to any time frame.
For an Up Reversal Bar (reverse the rules for a down Reversal Bar) -
• Reversal Bars work best in a developed trend – If a trend has been going for some time, then it is reasonable to wonder when it is going to end. The reversal bar can help. If a trend has previously been down, then the reversal bar (bar #2) should make a lower low.
• Close should be greater than the previous close: Not only should the price reverse back up, but it should do so convincingly.
• Close should be greater than the open: At the end of the day there is more interest in buying the market than selling it.
Ideally one should place a buy order above the high of the Reversal Bar and the stop below the low of the bar (for an up reversal bar). This would help take care of volatile spikes occurring in the next few bars.
In cases where a reversal bar might be a beginning of a retracement, rather than a change in trend the CCI can be a very good filter. With retracements the CCI generally doesn’t reach oversold/overbought areas and would warn us that the reversal bar does not mean a change in trend.
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