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Lesson 11: ZigZag

Lesson 11: ZigZag

The Zig Zag indicator lowers the impact of random price fluctuations and is used to help identify price trends and changes in price trends.

The Zig-Zag indicator is a basic tool that analysts use to find out when a security trend is reversing. Determining the support and resistance areas, helps to identify significant changes in price while filtering out short-term fluctuations, thus eliminating the noise of everyday market conditions. It is an excellent tool for any trader who follows indicators that use swing highs and swing lows.

How to use this guide

To get the most out of this guide, it’s recommended to practice putting this ZigZag indicator trading strategy into action. The best risk-free way to test these strategies is with a demo account, which gives you access to our trading platform and $50,000 in virtual funds for you to practice with. Get your free demo account.

Once you’ve found a strategy that consistently delivers positive results, it’s time to upgrade to a fully-funded live account where you can apply your newfound edge.

What is the ZigZag indicator?

The ZigZag indicator is a technical indicator that lowers the impact of random price fluctuations and is used to help identify price trends and changes in price trends.

The ZigZag indicator plots points on the chart whenever prices reverse by a percentage greater than a pre-chosen variable. Straight lines are then drawn, connecting these points. The indicator is used to help identify price trends. It eliminates random price fluctuations and attempts to show trend changes. ZigZag lines only appear when there is a price movement between a swing high and a swing low that is greater than a specified percentage; often 5%. By filtering minor price movements, the indicator makes trends easier to spot in all time frames.

What is the ZigZag indicator
Source: CAPEX WebTrader

ZigZag Parameter Settings

The Zigzag parameters are very important to cover enough price data so the indicator can display zigzag waves on your chart.

These are the Zigzag parameters input that you need to figure out:

  1. Depth – refers to how far back in the chart bar series it will look. In order to get the highs and lows defined you need to make sure you have enough “Depth.”
  2. Deviation – what percentage in price change does it take to change the trendline from positive to negative.
  3. Backstep - the minimal amount of bars between swing highs and lows.

It’s important to play around with these ZigZag settings until you find the ones that suit your trading style.

But, if the ZigZag parameters are set too tight, you can have a zigzagging effect. But we want to have a broader view of what the true swing high and swing low are.

When you set the Zigzag parameters you should be looking at three things:

  1. Price symmetry should give you nice and uniformly matched wave harmonics, namely the AB=CD pattern.
  2. Wave depth which should give you a good depth of waves between the swing highs and lows.
  3. Stepping price level should make sure that you’re able to spot a trend.

The zigzag indicator is one of the default technical indicators that come with your trading platform offered by the best CFD & Forex brokers.

The ZigZag indicator allows for huge versatility in technical analysis. ZigZag can be used for:

  • Spotting double tops and double bottoms
  • Entry points
  • Fibonacci tools
  • Harmonic patterns
  • Channels and chart patterns
  • Multiple ZigZag charting
  • Wolfe Waves
  • Keltner Channels

The ZigZag indicator is available on our online trading platform, WebTrader. Our award-winning platform allows traders to customize technical indicators and tools, add drawing tools to price charts and graphs, and identify chart patterns in order to improve their trading strategy.

The ZigZag Indicator Formula

ZigZag (HL, %change=X, retrace=FALSE, LastExtreme=TRUE)

If %change>=X,plot ZigZag

where:

  • HL = High-Low price series or Closing price series
  • %change = Minimum price movement, in percentage
  • Retrace = Is change a retracement of the previous move or an absolute change from peak to trough?
  • Last Extreme = If the extreme price is the same over multiple periods, is the extreme price the first or last observation?

How To Calculate the ZigZag Indicator

  1. Choose a starting point (swing high or swing low).
  2. Choose % price movement.
  3. Identify the next swing high or swing low that differs from the starting point = > % price movement.
  4. Draw a trendline from starting point to a new point.
  5. Identify the next swing high or swing low that differs from the new point = > % price movement.
  6. Draw a trendline.
  7. Repeat to the most recent swing high or swing low.

How to use the Zig-Zag indicator?

The ZigZag combination with the Elliott Wave Theory helps traders determine the positioning of each wave in the overall cycle. Traders can experiment with different percentage settings to see what gives the best results. For example, a setting of 4% may define waves more clearly than a setting of 5%. Stocks have their own patterns, so it is likely that traders will need to optimize the ZigZag indicator’s percentage setting to suit those currency pairs.

Although the Zig Zag indicator does not predict future trends, it helps to identify potential support and resistance lines between plotted swing highs and swing lows. ZigZag lines can also reveal reversal patterns, i.e. double tops and bottoms, rising and falling wedges, and head and shoulders. Traders can use popular technical indicators like relative strength index (RSI), ADX, and Stochastics oscillator to confirm the price of a security is overbought or oversold when the ZigZag line changes direction.

A momentum trader might use the indicator to stay in a trade until the ZigZag line confirms in the opposite direction. For example, if the trader holds a long position, they would not sell until the ZigZag line turns downward.

How to Trade with the Zigzag indicator

When you see the ZigZag swings and you want to place a trade, you can do so via derivatives such as CFDs. Derivatives enable you to trade rising as well as declining prices. So, depending on what you think will happen with the asset’s price when one of the ZigZag swings appears, you can open a long position or a short position.

Follow these steps to trade when you see the ZigZag swings:

  • Trading any type of technical indicator requires patience and the ability to wait for confirmation. ZigZag is used most to confirm the direction of the trend.
  • To get started trading with the ZigZag indicator, open an account. Choose between a live account to trade CFDs straight away or practice first on our demo account with virtual funds.
  • Choose your financial instrument. ZigZag swings can be spotted in most financial markets, especially those that are more volatile, such as forex, cryptocurrencies, and stocks.
  • Explore our online trading platform. We offer a wide range of technical indicators that are not limited to ZigZag, as well as providing a range of order execution tools for fast trading, which in turn helps you to manage risk.

*The below strategies for trading ZigZag swings are merely guidance and cannot be relied on for profit.

ZigZag Trading Strategy

The ZigZag technique presented below requires the use of one particular indicator. The Fibonacci retracement and extension will be used to additionally confirm the ABCD harmonic pattern. It will be used for trade management as well.

Step #1: Set the ZigZag settings at 20 for the Depth and 5% Deviation

First, we want to make sure the ZigZag tool will only show the more significant swing high and swing low points in the market. For this, we have to use the following ZigZag parameters: at least 20 periods for the Depth and 5% deviation to accurately display the market swings.

zigzag settings
Step #2: Plot the Fibonacci Extension line once the first two swing waves are established

In order to plot the Fibonacci Extension line, we need three points of reference. As soon as the first two waves of the ZigZag pattern are developed, we’re offered three swing levels. We’re going to use them to draw the Fibonacci extension levels.

ZigZag indicator MT5
Source: CAPEX MT5

The reason why we use the Fibonacci extension levels is to try to anticipate where the last swing wave of the Zig Zag combination will form.

The zigzag indicator will only mark the swing low as being formed too late for us to rely and base our trades alone on this indicator. This is the main reason we employ different trade tactics. The tactics are used to anticipate where it’s more likely for the zigzag pattern to end.

Step #3: Wait for the third wave to terminate between 1.0 – 1.272 or 1.272-1.382

The reality is that market symmetry doesn’t happen often. The harmonic patterns require a lot of precision in order to have all the conditions for this pattern to be valid.

Since we can’t know for sure where the third wave will end, we’re going to employ candlestick chart techniques to spot a swing point in the market.

Step #4: Wait until you have a bullish candlestick pattern

Bullish candlestick patterns may form after a market downtrend and signal a reversal of price movement. They are a chart pattern indicator for traders to consider opening a long position to seek profit from any upward trajectory.

To better understand how to spot when a swing low is about to be put in place we’ve made a simple illustration from one of the most appreciated Academy courses – Japanese Candlestick Patterns.

ZigZag strategies
Now you need this pattern to develop between the Fibonacci level. The trendline could offer more guidance as dynamic support and resistance.

Step #5: Look to go long at the close of the three-bar pattern

After the three-bar pattern is completed, the setup favors a long trade.

This brings us to the next important thing that we need to establish for the best Zig zag strategy, which is where to place a protective stop loss.

Step #6: Hide your protective Stop Loss below the three-bar pattern

The stop loss is going to go below the three-bar pattern. Your stop loss may be a little bit bigger depending on the time frame you’re trading.

You want to make sure that the three-bar pattern where your stop loss goes maintains at least a 2% risk.

You don’t want to risk more than 2% of your account in any given trade.

Last but not least, you also need to define where to take profits.

Step #7: Take profit should equal 2 or 3 times more than the Stop Loss

The classical ABCD pattern essentially keeps you at a 1:1 risk-reward ratio. Also, a lot of the time with the ABCD pattern, you’ll see it pretty frequently that those target areas are front-run.

However, when you trade with the Zig Zag indicator, you’re able to capture two or even three times more of the risk taken.

Final words about the ZigZag indicator

It is important to remember that the ZigZag feature has no predictive power because it draws lines based on hindsight. Any predictive power will come from applications such as Elliott Waves, chart pattern analysis, or trading indicators. Chartists can also use the ZigZag with retracements feature to identify Fibonacci retracements and projections.

Free trading tools and resources

Remember, you should have some trading experience and knowledge before you decide to trade with indicators. You should consider using the educational resources we offer likeCAPEX Academyor ademo trading account. CAPEX Academy has lots of courses for you to choose from, and they all tackle a different financial concept or process – like the basics of analyses – to help you to become a better trader.

Our demo account is a great place for you to learn more about leveraged trading, and you’ll be able to get an intimate understanding of how CFDs work – as well as what it’s like to trade with leverage – before risking real capital. For this reason, a demo account with us is a great tool for investors who are looking to make a transition to leveraged trading.

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