The Best Indicator You Might Not Know About

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    Traders have spent a great deal of time searching for indicators. Their goal is to find a market beating indicator that will allow them to outperform the stock market. It’s an effort that could well be worth the time but it often results in frustration.

    Some of the frustration comes from the fact that traders stay on the same path as those who went before them. They study the popular indicators and may try to profit from tools that millions of other traders have read about.

    Some may even try to follow the more popular indicators. They might try trading based on moving averages or popular indicators such as MACD, RSI or stochastics. Traders might simply apply the indicators using the default parameters while others will tweak the parameters slightly.

    But, trading is a difficult task and using popular indicators is unlikely to be the key to success. Older traders have often summarized this problem by saying “to know what everyone knows is to know nothing.” That means success will require digging deeper.

    An Overlooked Indicator

    Digging deeper could require developing a new indicator. But, it could also mean just reviewing the many indicators that have already been identified.

    Since individual investors often follow stocks, the name of one indicator that was developed many years ago might be the reason the indicator is ignored. That indicator is the Commodity Channel Index or CCI.

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  • This indicator was developed by Donald Lambert, a computer programmer who noticed cycles of varying lengths seem to be visible in commodity markets. Lambert was not a trader, he was a computer programmer and mathematician who viewed markets as math problems.

    He introduced CCI in 1980 to take advantage of new technology, the handheld Texas Instrument programmable calculator. For its time, it was a relatively advanced indicator and that fact could also explain why it was not widely used.

    Calculating CCI is a multi-step process.

    Source: DeWinForex.com

    At the time Lambert was developing the indicator, the typical price was widely used by commodity traders to find price targets. There were a number of formulas based on that idea among floor traders.

    The rest of the calculations are finding a value that Lambert said was similar to a “standard score” in statistics. The standard score is the number of standard deviations a value is from the mean. Lambert’s mean deviation provides a frame of reference of how volatile recent price action has been.

    CCI is the ratio of the current day’s price action to the mean deviation. The constant, 0.015 in the denominator of the final equation, is used so that 70% to 80% of CCI’s values will fall between -100 and +100.

    Of course, now you won’t have to calculate the indicator because it is available in a number of software packages and it is readily available online.

    Interpreting the Indicator

    Although Lambert suggested using values of -100 and +100 for trade signals, many traders now use -200 and +200. CCI can be used to signal a buy when the indicator becomes either overbought or oversold. Green vertical lines show buy signals for both conditions.

    There are a number of ways to use the indicator. Some traders will follow a strategy where CCI provides buy signals when it moves above +200 indicating an uptrend is beginning. When used this way, CCI is buying into sharp up trends.

    This signal will allow you to participate in markets that are strong or even in the early stages of a bubble. But, it will require buying into extreme strength and the risks of large losses are possible.

    The indicator could also be used to signal a buy when CCI moves above -200 after falling below that level. This shows buyers are moving into the stock after it sold off sharply and is using CCI to find oversold markets. These signals might be easier for traders to follow since it is buying after extended weakness.

    The chart of Nordstrom Inc. (NYSE: JWN) shows the latter signal below. Notice it came after an extended decline.

    JWN weekly

     

    At the right side of the chart, CCI is moving above 200, triggering a buy signal for more aggressive traders. A similar signal is shown in the left side of the chart of Invesco QQQ Trust (NYSE: QQQ), an exchange traded fund or ETF that tracks the Nasdaq 100 index, an index heavy with tech stocks.

    QQQ weekly

    As the charts above show, either approach can be used with success.

    Trading With CCI

    The charts above show successful signals but also highlight the difficulty of trading with CCI. One problem is that there will not always be sell signals to reverse the buy signals. Likewise, a trader may not get back into markets on CCI signals after a clear sell signal.

    This problem could be addressed by developing a clear exit strategy. The exit could use a second indicator, such as a moving average, a chart pattern that indicates a sell signal after the price action turns bearish or another indicator such as a more popular one like the RSI or MACD.

    If a second indicator is used, however, the trader has not really solved the problem since, again, there is no requirement that any indicator provides a signal at any time. For that reason, a moving average or a chart pattern analysis could be more useful.

    A second problem is that the signals are infrequent so traders may need to monitor many stocks to benefit from the few signals that are given.

    While the CCI is useful, it demonstrates that trading requires a great deal of effort to find trades and to follow the market action. If you are uncertain about having the time to dedicate to this effort, then the TradingTips.com service, PPK System, could be useful to you.

    The PPK System is designed to exploit patterns associated with market clues by looking for value and momentum in stocks and could spot the potential winners based on a variety of factors.

    This combination of value and momentum has been shown by many researchers to be the cornerstone of strategies that beat the market in the long run. The PPK System follows strict rules for buying and selling. You can learn more about this trading service by clicking here.