Using The CCI Indicator With The Candlestick “Reversal Bar” Pattern
In this lesson I will show you how to combine the characteristics of the CCI indicator along with the Reversal Bar candlestick to form a little trading method. I will be using the reversal bar and not the Key Day Reversal Bar (there is a difference).
First let us look at the basics of these two indicators to help us understand why we should combine them.
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.
For an Up Reversal Bar (reverse the rules for a down Reversal Bar) -
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.
I have marked the outside -200/+200 range in red lines, and the mid -100/+100 range in blue lines.
If you look at the example chart above and try to interpret the CCI without taking into account the Reversal bars, which are marked, then we have 2 situations where we have the CCI indicating the change of trend. The potential change in trend is indicated by the fact that the CCI has reached -200 or + 200 and is either overbought or oversold.
The first blue circle shows an oversold situation, where the CCI has turned up from the -200 level. This is an indication to go long and I would wait for the CCI to cross the -100 level before entering a trade.
The second red circle shows an overbought situation along with divergence, which is a strong signal to go short. Similarly, one would wait for the CCI to cross the +100 level down, before taking a short position.
The problem is that the CCI indicator is not strong enough as a stand alone method but when you also use reversal bars as a confirmation, it can be very accurate.
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.
Remember, all these lessons are meant to give you ideas that you can change, improve, test and mold to your own trading style.
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