V.11:6 (229-234): Cyclical Channel Analysis And The Commodity Channel Index by D.W. Davies

Cyclical Channel Analysis And The Commodity Channel Index by D.W. Davies

Trading bands and the commodity channel index, two popular indicators, are used together here by D.W. Davies, who publishes the "Chameleon" financial newsletter. Davies analyzes price direction using trading bands built around moving averages with different time periods as a form of cyclical analysis and uses the commodity channel index as a timing tool with the cyclical analysis to assist in generating trading opportunities.

Cycles exist in financial markets. That is accepted. Unfortunately, I found it difficult to identify and use cycles with any amount of precision or confidence until I discovered Brian Millard's concept of cyclical channel analysis (CCA). J.M. Hurst in the United States and Brian Millard in the United Kingdom independently and by different means developed the concept of CCA. Millard's concept of CCA is elegant but simple and I use it to predict time and price opportunities in the market. It is a powerful method to indicate future periods of exceptional probability of a price reversal. Once the opportunities have been identified, other means can be used to pinpoint the timing of entry or exit. One suggested method is the commodity channel index (CCI) (see sidebar, "Commodity channel index"), which is included in most analytical software.

In this article, I will outline Millard's method of channel analysis and then describe how the CCI can be used to pinpoint the time for entry and exit. The basis for Millard's channels are:

• A moving average (MA) shows only those fluctuations of price for periods greater than the value chosen for the MA, lessening the importance of those of lesser periods .

• The MA plot should be centered—that is, placed back in time half the numerical value of the MA. Some technicians place the moving average value on today's date. This is mathematically incorrect.

• Once this midpoint of the cycle (the centered moving average value) has been identified, then the theoretical end point can be calculated.

• Prices fluctuate around the average, forming a channel of variance about the average.

• A channel of variance can be drawn so that the lines of the channel passes through most of the extremes of the variance. This will be some percentage of the moving average price plotted above and below the moving average: a small percentage for short time periods and a larger percentage for longer time periods.

• If we can identify the channel of variance, then we can measure the amplitude of the cycle.