How to Use the CCI to Find Trades – Part 1

10/19/2009 11:25 am EST

Focus: STRATEGIES

John Jagerson

Co-Founder and Contributor, LearningMarkets.com

Divergences can be an important warning signal that a bullish trend is ending. Besides describing a bearish divergence with the CCI indicator, I will further refine divergence analysis to help you understand what types of divergences matter most and what you should be looking for on a day-to-day basis.

A bearish divergence occurs when prices continue to form higher highs (typical in a bull market) while your oscillator (CCI) is forming significantly lower highs (indicating weakness in the trend.) We have further defined this signal as a period of diverging trends between prices and the indicator when the indicator has been making peaks in the "overbought" territory.

If you are using the CCI to look for divergences, that means that you will pay the most attention to divergences when the indicator's peaks are above its normal range. You can see exactly this sort of formation and the resulting down trend on the chart below of the US Dollar Index.

chart
Click to Enlarge

There are two things that a technician can do once a divergence forms and prices start to drop. First, it is an opportunity for long traders to be proactive about their risk control. That may mean using tighter stops, protective options or just reviewing your portfolio to make sure you are properly diversified. Second, a bearish divergence is a great timing signal for more speculative traders to get short the market or to buy put options. In either case, the signal has given you actionable information for your own portfolio management.

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By John Jagerson, of LearningMarkets.com.

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