Using the Zig Zag Indicator to Create a Forex Trading Strategy

The Zig Zag indicator, named for the pattern of straight lines that appear to zig-zag across a technical analysis chart, operates as a filter for directional changes in price movements. Technical analysts and forex traders apply the Zig Zag filter to remove unnecessary noise from the price chart; the goal is to focus on the important trends, not insignificant fluctuations. This indicator should never act as a trading system on its own. Instead, the Zig Zag indicator is best used to highlight important patterns and confirm possible trend reversals.

Key Takeaways

  • The Zig Zag indicator is a basic tool used by traders to identify possible trend reversals.
  • The indicator is not the only tool a trader should use to make investment decisions.
  • When starting a possible trade, the Zig Zag indicator should be the first tool used. Confirmation is then required from other, more precise trading tools. These depend on the individual trader and their overall strategy.

How the Zig Zag Indicator Works

The Zig Zag indicator is easy to understand and apply. Price changes below a specific threshold, normally 10% or 20%, are removed from trendlines through a filtration process. Most trading software or online trading platforms have simple input fields that allow you to set the parameters of your own Zig Zag preferences.

Keep in mind that the higher you set the price change threshold, the less sensitive the indicator becomes. If you set too low of a spot, it results in an ineffective Zig Zag since not enough noise is removed. Too restrictive and you may miss profitable price trend data. Most default settings have a threshold between 8% and 15%, although this has as much to do with the individual trader's strategy as it does with overall price movement.

Trading Forex With the Zig Zag

The Zig Zag tool is designed to be complementary and should not be the focal point of a forex trading strategy. It is most commonly used in conjunction with Fibonacci or Elliot Wave trading systems. Swing traders love the Zig Zag because it helps them analyze entries on possible retracements.

The Zig Zag indicator exists in order to apply consistency to trading signals.

This should translate into a more consistent application of other trade strategies. Whatever trading strategy you use, keep in mind that the Zig Zag is a lagging indicator, which means that it does not predict anything on its own. The forex market is notoriously fast-paced, so try to complement it with a system that offers leading signals if possible.

Like many trading indicators, long-term trend reversals take more time but are shown to be more reliable than indicators that show short timeframes, like those of days, hours, or minutes.

Many traders trade with a variety of tools. The Zig Zag indicator shows when a trend could be reversing, but the trader will compare that indication against other trading tools they use in order to execute their strategy. Common forex trading tools are volume indicators, buy/sell momentum indicators, and relative strength indicators, called RSIs.

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