by Joe Ross
(Previously published in Futures Truth Magazine.)
Let’s see how we can use the CCI study in a way that few have seen before. We’ll take it a step at a time. (The CCI study is available in most charting software packages.)
The CCI measures the mean deviation of a bar’s Typical Price relative to a moving average of N bars’ Typical Price. Typical Price may be computed as the high plus the low plus the close, divided by three. This gives a close-weighted Typical Price.
The CCI study is a volatility indicator generally displayed with three horizontal lines: +100, 0, and -100. However, CCI is theoretically, if not practically, infinitely expandable.
There is one great advantage to the scale. It is increasingly difficult for CCI to make ever greater extremes in its readings. It takes increasingly more volatility to push the CCI plot increasingly further out on its scale.
Experience and testing have shown that a 30-bar CCI works best for trend following.
Any software which allows us to insert a fictitious price bar can be used to emulate the manner in which we use the CCI at Trading Educators. However, this CCI technique can be done quite satisfactorily without the use of the fictitious bar.
To insert a fictitious reading for CCI, we need to be able to create a hypothetical price bar for what will be the next price bar. This is easily done on a daily chart with most software. On anything less than a 15-minute chart, we will have to really scramble to get the job done. The truth is that the calculation of a fictitious price bar works best on an hourly, daily, or weekly chart. Once we have placed the hypothetical bar on the chart, simply run the CCI study with the hypothetical bar in place, and see what the reading will be.
The hypothetical bar need have only one price for all fields. The open, high, low, and close can all be the Typical Price, but if our software will allow, we can also insert a high and a low if we want to do the extra work.
How do we know what the next bar’s Typical Price might be?
I’ll show two ways to do it. Then I’ll show how to use CCI as a trend-following tool that will keep us in a well established trend.
Figuring the next bar’s Typical Price in congestion has been done essentially this way since the inception of exchange trading. Each day many insiders and market makers come to the exchange with these figures in hand. They tend to sell at or near the typical high and buy at or near the typical low. If either the high or the low is violated by more than a few ticks, we see them bail out and run for their lives. This shows up on a chart as an extra long intraday bar.
Figuring the next bar’s Typical Price in Congestion
(Open + High + Low + 2(Close)) / 5 = X
2X minus The High = Next Bar’s Projected Low
2X minus The Low = Next Bar’s Projected High
O H L C
Example: (24 + 25 + 23 + 2(23.5)) / 5 = 23.8
2(23.8) – 25 = 22.6 = Next Bar’s Projected Low
2(23.8) – 23 = 24.6 = Next Bar’s Projected High
Next Bar’s Typical Price = (Next Bar’s Projected Low + Next Bar’s Projected High) / 2
(22.6 + 24.6) / 2 = 23.6
Figuring the Next Bar’s Typical Price in a Trend
Typical Price in an Uptrend
To compute the next bar’s Typical Price in an uptrend, we need to find the average rate of ascent. It’s important to use four bars for this computation.
What we want to know is, on average, how much prices are moving in the direction of the uptrend. To find out, we measure from low to high.
Here are the steps to follow:
We measure from one bar’s low to the next bar’s high, to see how far prices move over a two-bar period. We do this for three overlapping two-bar periods.
Here is an example:
We then add the “amount moved” measurements together, and divide by three.
2 + 3.75 + 3.25 = 9. 9÷3 = 3 on average.
Adding 3 to the last known low (29.25), we obtain the number 32.25, which is the next bar’s projected high.
Next we need to determine tomorrow’s projected low.
We measure the average volatility for the last three bars. Average volatility equals the sum of the differences between high and low, divided by three.
31.00 – 29.25 = 1.75
30.25 – 27.75 = 2.50
28.00 – 26.50 = 1.50
The three differences are 1.75, 2.50, and 1.50.
Summing these and dividing by 3 = 5.75÷3 = 1.92 (rounded).
Subtracting 1.92 from the projected high (32.25), we obtain 30.33 for the next bar’s projected low.
The final step is to add the projected high to the projected low, then divide by two to come up with a Typical Price.
In this case, (32.25 + 30.33) / 2 = 31.29.
It’s important to realize that this is not an exact science, but it’s surprising how often we can come within a tick or two of being right.
Stay tuned for the follow up posts on this excellent article!