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.
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 the threshold between 8% and 15%.
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 retracements.
The Zig Zag indicator is there 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 does not predict anything on its own. The forex market is very fast paced, so try to complement it with a system that offers leading signals.