When looking at the charts, sometimes we can confuse ourselves by seeing things that aren’t really on the screen. The zig-zag indicator is something that can help filter out insignificant price action and help us concentrate on the important data.
The Zig-Zag indicator can be used for:
- Pinpointing tops and bottoms
- Assisting with an Elliot Wave count
The ZigZag indicator utilises sectional lines to connect significant tops and bottoms of the price. See an example here for the price action in the USDJPY D1 chart:
Note: The completed impulse wave to the upside, EWT traders know what comes next.
The ZigZag indicator connects extreme points of the chart, the distance between these points being equal to or higher than the percentage specified for the price scale.
To use the ZigZag indicator, a percentage of price movements must be set. Although the default value for a ZigZag deviation is 5, a setting of 10 would ensure that only price fluctuations of 10% or more would be shown in the chart. This eliminates smaller price swings and allows the analyst to see the bigger picture.
Normally, the closing prices of Forex pairs are used, and imaginary points are placed on the given chart where the price reverses by the set percentages. These points are then connected by straight lines, red by default, and the ZigZag appears.
The default settings are shown in the screenshot above, here’s how to read them.
Depth is the first setting of the ZigZag indicator. This is the minimum number of bars with no second maximum or minimum deviation from the bar.
Deviation is the number of pips or points (depending on the market) after the previous minimum or maximum is formed.
Backstep is the last setting and reflects the minimum amount of bars between which the high and low can be plotted.
These settings should be adapted to various markets. You will probably end up using different settings for one market or instrument versus another. Additionally, you could also end up changing the settings for the same market or indicator when the market conditions change along with its volatility.
Correct use of the zig-zag indicator can help you filter out some of the chaos in the market and concentrate on what’s important, making money.