There many different techniques investors and traders use, in order to predict short term stock market movement, among them, there’s the powerful indicator CCI (Commodity Channel Index).
But unlike the traditional momentum overbought/oversold readings, here is how it can be used more effectively for predicting trend reversals…
This CCI indicator can be used extensively with the techniques of Divergence trading and Trendline breach.
1. Divergence trading is based on the divergences that occur between the actual market price and the price of the indicator, as you can see on the chart below, the grey set of lines represent divergences. If you compare the first grey line on the market chart, to the corresponding grey line on the CCI indicator chart below it, you will notice that this market actually made a higher high, while its CCI reading made a lower low.
When this happens the market will move in the direction of the indicator! In this case down. You can see the next divergence in grey, this time suggesting an up market move!
2. Trendline breach trading on the other hand, is when the indicator itself forms a trend line of resistance, and finally breaches it. This kind of bullish signal actually leads the market, and as you can see on the green line on the CCI chart below, the trendline breach does predict the rally in the market well in advance! Trendlines on CCI can be either resistive or supportive, and give out bullish or bearish breaches respectively.
Another example on (JPM) – divergences only :
Predicting Trend Reversals – Conclusion And Tips
The most reliable divergences occur on formations that have been made over many days, for example 10 to 60 days, and these can actually predict sharp reversals in the markets, such as corrections. Divergences cannot predict major trend reversals unless they agree with other indicators as well.
To be safe in making a divergence based trade, one has to look on the daily, weekly, and even monthly charts of the markets. They are more than enough as a prediction tool for those who invest long term in the stock markets, for short term traders however, they may give conflicting signals from time to time, and they should be interpreted with extreme caution!
All in all, divergence and trendline signals on the CCI indicator are much more meaningful than the indicator’s actual numerical value, and they form all the time. The longer the time frame of course, the more reliable the signal is.
So what to do if a divergence shows up? It’s simple, if a bearish divergence shows up and you are long in the stock market, you should remain long, but you should tighten your stop loss orders (On long stocks, stock margin trading, futures, options), you can use stop loss orders. When the markets sharply fall, you will have tight stops in place and they will get you out at almost no loss! – So they serve as an advanced warning indicator telling you to tighten your stops.
CCI trendline breaches are reliable when a falling resistance trendline is breached and suggests a buy signal, as in the chart above. If we had the breach of a rising resistance trendline it would be considered a false buy. When trying to predict trend reversals, always make sure that resistance is a falling trendline and support is a rising trendline on the CCI chart.
Stock Market Investing Strategies and Market Speculation by..
Scott Smith
Investing The Stock Market © 2008 – 2010
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