Zig Zag Indicator

Introduction

Within the realm of stock trading it’s difficult to not get overwhelmed at times with all the sudden price changes or fluctuations as that can make discerning trends even more challenging.

So if you’re a trader that likes to trade along trends or wants to benefit from reversals or divergences then trend identification is no doubt on your list of priorities.

But how can you even begin to accurately assess those trends in the first place? 

And the answer to that is indicators, yes indicators like the RSI, the Stochastic Oscillator, or any of those several moving averages that aim to filter out market noise and provide a good idea of where the market is heading towards.

But this time it’s the Zig Zag Indicator that has our attention now here so without further ado lets get into it.

What is Zig Zag Indicator?

It was Ralph Nelson Elliott who’s responsible for the creation of the Zig Zag indicator and if you don’t know who he is well he’s a financial analyst who’s well regarded for his work concerning the Elliot Wave Theory which has to do with predicting market prices and trends via this series of wave-like patterns.

But the Zig Zag indicator as its commonly applied within technical analyses was first popularized by the trader and author Robert Miner who has written a book titled “Dynamic Trading: Dynamic Concepts in Time, Price, and Pattern Analysis With Practical Strategies for Traders & Investors”.

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The Purpose of Zig Zag Indicator

The Zig Zag is basically made to lower the effects of random price fluctuations to then better identify price trends or changes within price trends without all that market noise.

The Zig Zag indicator basically plots points on charts whenever those prices reverse by this percentage thats higher than a pre chosen variable.

If you as an analyst wants to set that percentage level that triggers the indicator to your liking then you can do so so that it meets your trading requirements.

Straight lines may then be drawn linking those points. 

So those Zig Zag lines only tend to appear when theres price movements between swing lows and swing highs thats higher than that specified percentage which is often 5%.

By filtering out those minor price movements the indicator can make trend a bit easier to spot within every time frame.

How is Zig Zag Indicator Calculated?

Although you don’t have to calculate those values yourself considering how any trading platform that supports it will do everything for you with your only input being to tweak the settings a bit to match your trading style.

But if you happen to be more of a curious type of individual and generally want to know what goes all those figures and calculations then read on if not you could just skip ahead.

Zig Zag Indicator Calculation Steps

So the first thing you have to do is choose the point move or minimum percentage basically as a sort of threshold for price changes to be regarded as significant.

For instance if you pick a %5 change then the price has to move beyond that from the previous lines drawn to draw new ones.

Then identify those pivot points which are those troughs and peaks based on the threshold you’ve set and finally connect those pivot points by straight lines which essentially makes that zigzag pattern that shows only the most substantial price moves or changes.

Key Characteristics of Zig Zag Indicator

As for the formula itself well that can vary depending on the platform you’re using but a simple ZigZag formula thats percentage-based would look something like this.

For the uptrend line you have:

• High Point = Current High if (Current High – Last Low) > (Percentage * Last Low)
• ZigZag = Last Low if High Point is valid

But if its a downtrend line then the formula is this:

• Low Point = Current Low if (Last High – Current Low) > (Percentage * Last High)
• ZigZag = Last High if Low Point is valid

So the key characteristics based on what can be deduced so far has to be the percentage change obviously as that forms a large part of what makes this indicator. 

Besides that those highs and lows matter too so they’re quite important too.

How to Use Zig Zag Indicator in Trading

However knowing what the indicator can do is one thing but actively using it in your trading is quite another so you need to know how its normally used in trading to gain a better understanding of its practical aspects. 

Identifying Trends

The Zig Zag indicator is made to have a mostly noise free view of trends where only the significant swings tend to be counted and because of that you have a much clearer trend line or view of the market. 

So its quite good if you like to trade along trends. 

Spotting Reversals

Besides identifying those price trends the indicator may even help traders spot possible reversals within the market.

So when the indicator shifts its direction it can signal another change within the price trend.

A good example of this phenomenon is how at times the Zig Zag indicator may start to form a series of higher lows and higher highs and if it starts to change to lower highs and lower lows then you could have a potential reversal on your hands.

Using Zig Zag with Other Indicators

Sometimes using an indicator on its own isn’t enough you might want to combine other indicators with it to either complement it or improve its accuracy or rather the reliability of your trading decisions as thats something you can never have enough of especially if its the stock industry we’re talking about.

So you as a trader could use other popular indicators with it and some of them may be the RSI or Relative Strength Index and the Stochastic Oscillator to verify lets say whether or not the security’s price is oversold or overbought when the Zig Zag line has shifted its direction.

Zig Zag Strategies for Different Trading Styles

But what about those trading styles that you find so many traders using namely day, swing and long term trading? 

How can the Zig Zag relate to those?

Day Trading with Zig Zag

Well for day trading since the focus is mainly on short term gains that %5 change may not be worthwhile considering that price increments of that proportion may not be that common given the shorter time frames that you see such traders adopting unless its an extremely volatile market of course which would change things then.

Still if you can then you could try lowering that percentage change to make the indicator more responsive to price changes..

Swing Trading with Zig Zag

But if you’re a swing trader then that %5 may just be what you’re looking for considering your focus would mostly be on medium to long term gains.

Also you could try adjusting the time frames or the look back period to better reflect your style.

Long-Term Investing with Zig Zag

But what about long term trading which generally tends to emphasize long term gains or strategies? Well then the Zig Zag indicator can be tweaked to your liking too just like the day and swing traders. 

Start by using longer time frames and once that’s done you may want to increase that percentage change.

Why? Well since you’re in for the long haul a 5% change may not cut it you might want to make more profits with your positions so you might be looking for a 10% or even a 15% change.

A common strategy would be you buying the stock when its within an oversold phase and then waiting until it hits that percentage change you set to then sell it.

Advantages and Limitations of Zig Zag Indicator

Knowing both the advantages and disadvantages of the Zig Zag indicator would go a long way in you being able to make the most out of it as that way you’ll be able to mitigate its limitations.

Benefits of Using Zig Zag Indicator

The indicator can be viable tool for some clear trend identification or direction as it can filter out that market noise.

Its also flexible too in that it can support various trading styles.

Limitations of Zig Zag Indicator

You should know that the Zig Zag indicator is not a predictive indicator, its just meant to confirm trends and filter out some noise and because of its nature it may not be that good within range markets considering the fact that the prices don’t fluctuate as much in those.

Conclusion

If its historical analysis you’re concerned with then the Zig Zag can be efficient tool in your arsenal considering how its based on hindsight only and isn’t predictive in any shape or form since it uses only the past prices.

So you may not want to use it for any forecasting thats for sure.