You can use the zig zag indicator to make money on Forex.
It can give you a clear view of the market price swings on various time frames.
You can use this pattern for day trading, swing trading, or even scalping.
The Forex market will never move straight up or straight down.
If you have traded for some time, you must have noticed this.
Every price movement is associated with peaks and valleys, ups and downs, waves or price swings.
Whether trading upwards or downwards, you will still get this wave price movement.
This results from interactions between the bulls and the bears in the market.
When the bulls take control of the market, the price of the currency pair will increase.
The bears will join the market and try to push the price of the currency pair downwards.
When the bears take control of the market, the price of the currency pair will begin to decrease.
The bulls will join the market and try to push the price upwards.
The interaction between these two forces will always result into the formation of waves in the market, whether the price is moving upwards or downwards.
You can use the zig zag pattern to identify high percentage areas to ride those waves .
If you want to trade chart patterns, the zig zag pattern is a great technical indicator for you.
It includes Elliot Waves analysis, Fibonacci retracements, or any other type of price action that uses the concept of wave analysis.
The indicator is also a powerful tool for identifying the various chart patterns in the forex market.
In this article, I will be showing you how to use the zig zag indicator to make money on Forex.
What is the Zig Zag Indicator?
This is an indicator that measures the swing lows and the swing highs of a market.
It helps forex traders identify the market swing high and low points with a high degree of accuracy.
It is a good tool for Forex traders to filter out the market noise.
The indicator tries to find the support and resistance areas, price trends, and classic chart patterns like double bottoms and double tops, head and shoulders patterns, and others.
The indicator uses both swing lows and swings highs in its calculations…
- Swing Highs- These are formed when the price (usually close) is higher than both the price previous to it and after it.
- Swing Lows- These are formed when the price is lower than both the price prior to it and lower than the price following it.
- The indicator can use either points or percentages in its construction.To construct the indicator, there must be a certain percentage or number of points between the swing high and the swing low before a line is drawn.Consider the following chart…
The above chart shows a zig zag indicator of 2% deviation on a chart.
The indicator ignores the small price movements in the market to help you see the bigger picture.
If you observe the indicator closely, you will realize that it doesn’t swing when the price action makes a minor swing.
This is the case with both minor swing highs and swing lows.
Instead, it ignores such price swings and considers only the major ones.
That is how it removes noise from the price action.
The parameters for the indicator are very important to cover enough price data so that the indicator can show zigzag waves on the chart.
The following are the two zig zag indicator parameters that you should configure…
- Depth- This parameter denotes how far back in the chart bar series the indicator will look.
For you to get the lows and highs defined, you must ensure that you have enough depth.
- Deviation- This is the percentage in price change that it takes to change the trendline from positive to negative.
It will be good for you to play around with the values of these parameters until you get what suits your needs.
The good thing is that most trading platforms allow traders to set these parameters to values of their choice.
If you use a less percentage for the deviation, the zig zag will make more distinct lines than when you use a large percentage.
The reason as to why traders use a large percentage for the deviation parameter is to eliminate the price noise that may not be significant for the trader’s analysis.
So, the deviation parameter plays a significant role in helping the traders filter out noise in the price action.
If you want less noise, use a higher value for the deviation.
If you want to see even the smaller price swings, use a smaller value for the deviation.
Let us change the deviation percentage to 3% for the previous chart.
This is shown below…
In the above chart, we are using a deviation of 3%.
The indicator only shows two lines.
The indicator has removed the swings that it showed when the value of deviation was 2%.
The reason is that it has eliminated much noise in the price action.
This way, you can get a bigger picture from the price analysis.
From what you’ve seen above, the zig zag tool is very simple when it comes to settings.
There are only two variables that you need to set.
Despite having only two settings, you can tweak the indicator parameters to suit different market conditions.
Each trading platform comes with different default settings for the indicator parameters.
However, you can modify these settings to suit your own needs or reflect the underlying market conditions.
Is there Best Setting for the Zig Zag Indicator?
Now that you know much about this indicator, what is the best setting for it?
This is a common question among many Forex traders.
There are many theories that attempt to answer this question, but the fact is that the best settings for this indicator will vary from market to market.
If you are trading forex currencies, the settings that you use may not work for stocks.
Other than the factor of the instrument or asset being traded, the aspect of volatility is also very important.
Volatility plays a huge role and it can make the current settings unusable.
This means that when trading using this indicator, you have to constantly watch the settings of the indicator then adjust them accordingly depending on the market conditions.
You may end up changing the settings of the indicator for the same market because of changes in the market conditions.
Other than the standard zig zag indicator that is available, it’s possible for you to find a variation for the tool.
There are different variations for this indicator provided by different trading platforms.
Interpreting the Zig Zag Indicator
The indicator can be used to filter short-term noise and identify significant trends and changes in the market prices.
You can use the zig zag pattern to find out the support and resistance levels as well as price breakouts in the market.
Consider the chart given below…
The above chart uses a deviation of 2%.
This means that the chart only shows price changes of 2% and above.
The chart shows that it can help a long-term trader identify areas of support, resistance, and price breakouts.
The price action appears to be forming a triangle chart pattern.
This has been shown by the two black lines on the chart.
The upper line acts as the resistance, hence, it has been marked as Resistance.
The lower line acts as the support, hence, it has been marked as Support.
The price action swings in between these two lines for some time.
It finally breaks out through the support line in a bearish direction.
The breakout point is where the zig zag tool and the support line meet.
This has been shown on the chart using a black arrow marked as Price Breakout.
This should send a sell signal to the traders, meaning that it is a good time for them to take a short position.
So, the indicator can help traders identify the support, resistance, and price breakout levels.
Consider the chart given below…
The price action in the above chart is also forming a triangle chart pattern.
This has been marked by the two black lines on the chart.
The zig zag shows that the price action is swinging in between the two black lines.
The upper line is acting as the resistance, hence, it has been marked as Resistance.
The lower line is acting as support, hence, it has been marked as Support.
After some time, the price action managed to breakout of the triangle pattern through the resistance in a bullish direction.
This is the area on the chart where the zig zag tool meets the resistance line.
This position has been shown by a black arrow marked as Price Breakout.
This should send a buy signal to the traders, meaning that it is a good opportunity for them to take a long position.
So, it’s time for you to buy the currency pair.
Consider the chart given below….
In the above chart, the zig zag tool helps us to identify a head and shoulders pattern.
The price action was able to form the two shoulders and the head for the chart pattern.
Finally, the price action broke out through the slanting trendline in a bearish direction.
This should send a sell signal to the traders, meaning that they should take a short position.
This is the right time for you to sell the currency pair.
So, the zig zag is a technical analysis tool that can be used to identify classic charting patterns.
The indicator also helps in visually reducing noise, helping technical traders to see larger picture patterns and the general market direction.
How to Use the Zig Zag Indicator in Forex
As we stated earlier, this indicator can be used in a number of ways.
It can help Elliot Waves traders with wave counts and act as a confirmation tool.
The indicator can also help traders to identify Harmonic patterns.
In fact, it is a critical element of the zup indicator, a great indicator for recognizing harmonic patterns.
Note that the zig zag pattern repaints.
This means that in case a new high or low is formed within the parameters, the indicator will repaint again.
If you need to visualize this process, just add the indicator to any chart in real time and see how it will repaint.
Although the indicator seems to be constant, it is a dynamic and self-adjusting tool.
Most traders don’t like to use repainting indicators because they think that they are not reliable.
However, a repainting indicator simply adjusts to the prices as they happen.
Hence, in a way, this indicator frequently adjusts to the highs and the lows, until a new major low or high is formed.
Based on Fibonacci analysis, price normally retraces 38-50% of the previous leg.
When this is combined with the swing levels provided by the zig zag pattern, we get an overlapping confluent signal.
Additionally, after a news release, the market may trend very strongly and show minor retracements.
In such a case, you should use a more sensitive zig zag setting so as to adjust to the new trending market conditions.
As you keep on practicing, you will learn to recognize the behavior of this indicator on your price chart.
However, it’s not good for you to use this indicator in isolation.
Instead, use it alongside other technical analysis tools to ensure that you get an overlapping confirmation of signals.
For example, using the zig zag technical indicator with a longer term moving average can be seen as a zig zag indicator strategy where the longer term moving average can confirm whether the market is bullish or bearish.
The zig zag technical indicator can then give you the entry signals in the direction of longer-term trend.
So, if the longer term moving average shows you an uptrend, just look for a zig zag low to form, wait for the price to retrace from the low in order to confirm that the bottom is formed then buy into the market.
What Trading Strategies can be used with the Zig Zag Indicator?
You already know that this indicator can be used to identify different chart patterns.
We have used it to identify two chart patterns, the triangle pattern and the head and shoulders pattern.
The classical chart patterns like the head and shoulders pattern, rising and falling wedges, and triangle chart pattern can easily be identified using the zig zag tool.
This approach is ideal for use in trading strategies that are based on price action analysis.
You can also combine the zig zag tool with other technical indicators.
A good example is the moving average crossover.
Consider the chart given below…
The above chart shows how to combine the zig zag tool with the moving average on the same chart.
The moving averages are the two wavy lines running across the chart.
I have used 20 and 50 moving averages.
From the moving averages, we can tell that the market appears to be moving in a range.
The reason is that the moving averages appears to be showing a sideways movement.
A closer look at the price action also reveals the same.
Suddenly, the moving averages begun to make a bullish move.
The question is…
Now that the market is in a bearish trend, what is the best time for you to buy the currency pair?
The zig zag indicator can help you determine the best position to buy the pair at retracement bottoms.
The red arrow shown on the chart shows the formation of a swing high near a recent resistant area.
This was followed by the formation of a low shown by the black arrow on the chart.
After the formation of the low, the price made a strong bullish move, managing to break through the resistance level.
You can enter a long position after the occurrence of this breakout.
This is the position where the price action and the zig zag tool manage to break out through the resistance level in a bullish direction.
If you look at the chart well, the price of the currency pair continued to increase even after the occurrence of the breakout.
Any trader who had entered a long position after the breakout will make a profit.
So, other than the zig zag tool and the moving averages, you can look at the general price action and the candlestick patterns as additional confirmations before taking the long positions.
However, it’s not good to leave your long trade unprotected.
You can use a stop loss to protect your trade.
But, where should you place your stop loss order?
Just place it below the last low that was formed by the price action.
This is shown in the following chart…
The above chart shows the ideal place where you should place your stop loss order.
This is the position just below the last low that was formed prior to the occurrence of the strong bullish move.
In case the price action reverses and begins to move in the bearish direction, your profits will be protected.
The reason is that the stop loss order will be triggered and you will exit the trade, preventing your profits from being wiped out of your trading account.
The zig zag trading system is very simple and yet powerful, and you can enhance it a bit through further testing.
If you combine it with other technical based approaches, your analysis will become clear and you will increase the probability of your trade setup.
The Zig Zag Indicator vs. Simple Moving Average
The zig zag tool is very powerful in cutting through the market noise and locating the turning points of the chart.
The turning points denote the positions where trends turn from one direction to another and aggregate price rises turn into falls.
The vice versa is also true.
Consider the following chart…
The above chart is a comparison between the zig zag tool and the simple moving average.
Note that I have used SMA-10.
From the chart, you can tell that there is a difference in the location of the peaks and troughs.
The simple moving average smooths out the extreme highs and lows, but it erodes much of the finer detail of the price action.
Due to this, it responds slowly to changes in the price, producing a delay.
That is why the simple moving average appears to be lagging behind the real changes as they happen in the market.
The exact location of the peaks and troughs is blurred away, shifting them further to the right, or later in time.
If you compare the position of the peaks and troughs as shown by both the price action and the SMA-10, you will realize that the price action shows the peaks and troughs first compared to the SMA-10.
However, this is different with the zig zag tool.
It shows an instantaneous response to the price change.
The peaks and troughs of the zig zag tool line up very well with what we can call the turning points.
If you compare the position of the peaks and the troughs as shown by both the price action and the zig zag tool, you will realize that they are formed at exactly the same position.
This means that with the zig zag tool, you can get the finer details as shown by the price action compared to when using the simple moving average indicator.
Limitations of the Zig Zag Indicator
The zig zag tool doesn’t come with any magic.
It cannot foresee the future and alert you when the market is about to change direction.
It only introduces a delay of a few bars before it can draw the last line on the chart.
This is an indication that this indicator will always back draw or repaint into the past.
The newest line on the chart will update until the algorithm decides that the market has hit a new pivot point.
At that point, the indicator will commit and fix the line then begin to draw a new one.
So, the newest line on the chart will move around until the algorithm is sure that the market has reached a turning point instead of a minor price correction.
That is how you can use the zig zag system in your trades.
This is what you’ve learned in this article…
- Visually, the zig zag tool looks like an unbroken line similar to a zig zag, from which its name was derived.
- The forex market will never move straight up or straight down, but it will always swing to form peaks and troughs.
- The peaks become the highs while the troughs become the lows.
- The zig zag tool helps traders to flatten the trend by moving straight up and straight down by ignoring the insignificant highs and lows.
- This means that the indicator is useful to traders who need to eliminate the noise in the market.
- It does this by ignoring the insignificant swings made by the price action.
- The zig zag tool can help you plot the support and resistance levels on your chart.
- The indicator can also help you identify the classical chart patterns.
- The indicator is also common in harmonic trading.
- Since harmonic trading measures price retracements and extensions, the zig zag tool can help you to identify these price levels.
- You can also use this indicator to count the Elliot waves.
- However, many are the times that you will need to make adjustments to the parameters of the indicator since the process of counting Elliot waves can be subjective under some circumstances.
- As a trader, it will be good for you to test this indicator using your own technical approach.
- Spend time testing this indicator and you will know how you can apply it in your trading strategies.