What is the Zig Zag Indicator?

The Zig Zag 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. Zig Zag lines only appear when there is a price movement between a聽swing high聽and a swing low that is greater than a specified percentage; often 5%. By filtering minor price movements, the indicator makes trends easier to聽spot in all time frames.

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Key Takeaways

  • Lowers noise levels, highlighting underlying trends higher and lower.
  • Works best in strongly trending markets.

The Formula for the Zig Zag Indicator Is:

ZigZag(HL,%change=X,retrace=FALSE,LastExtreme=TRUE)If聽%change>=X,plot聽ZigZagwhere:HL=High-Low聽price聽series聽or聽Closing聽price聽series%change=Minimum聽price聽movement,聽in聽percentageRetrace=Is聽change聽a聽retracement聽of聽the聽previousmove聽or聽an聽absolute聽change聽from聽peak聽to聽trough?LastExtreme=If聽the聽extreme聽price聽is聽the聽same聽overmultiple聽periods,聽is聽the聽extreme聽price聽the聽first聽orlast聽observation?\begin{aligned} &\text{ZigZag}(\text{HL}, \%change=X, retrace=\text{FALSE},\\ &LastExtreme=\text{TRUE})\\ &\text{If } \%change >=X, \text{plot ZigZag}\\ &\textbf{where:}\\ &\text{HL}=\text{High-Low price series or Closing price series}\\ &\%change=\text{Minimum price movement, in percentage}\\ &Retrace=\text{Is change a retracement of the previous}\\ &\text{move or an absolute change from peak to trough?}\\ &LastExtreme=\text{If the extreme price is the same over}\\ &\text{multiple periods, is the extreme price the first or}\\ &\text{last observation?}\\ \end{aligned}ZigZag(HL,%change=X,retrace=FALSE,LastExtreme=TRUE)If聽%change>=X,plot聽ZigZagwhere:HL=High-Low聽price聽series聽or聽Closing聽price聽series%change=Minimum聽price聽movement,聽in聽percentageRetrace=Is聽change聽a聽retracement聽of聽the聽previousmove聽or聽an聽absolute聽change聽from聽peak聽to聽trough?LastExtreme=If聽the聽extreme聽price聽is聽the聽same聽overmultiple聽periods,聽is聽the聽extreme聽price聽the聽first聽orlast聽observation?

How To Calculate the Zig Zag Indicator

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

What Does The Zig Zag Indicator Tell You?

The Zig Zag indicator is often used in conjunction with聽Elliot Wave Theory聽to 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 Zig Zag indicator鈥檚 percentage setting to suit those securities.聽

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

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

Limitations of the Zig Zag Indicator

Like other聽trend-following indicators, buy and sell signals are based on past price history that may not be predictive of future price action. For example, the majority of a trend may have already happened when a Zig Zag line finally appears.

Traders should be aware the most recent Zig Zag line may not be permanent. When price changes direction, the indicator starts to draw a new line. If that line does not reach the indicator鈥檚 percentage setting and the price of the聽security聽reverses direction,聽the line is removed and replaced by an extended Zig Zag line in the trend鈥檚 original direction.

Given the lag, many traders use the Zig Zag indicator to confirm the direction of the trend rather than attempting to time a perfect entry or exit. (For further reading, see:聽How do I use the Zig Zag Indicator to Create a Forex Trading Strategy?)