Author: Nikolay Kositsin
Forum on trading, automated trading systems and testing trading strategies
newdigital, 2013.09.26 08:26
The Zig-Zag indicator is extremely useful for determining price trends, support and resistance areas, and classic
chart patterns like head and
shoulders, double bottoms and double tops. The Zig-Zag
indicators uses both swing highs and swing lows in its calculation:
The Zig-Zag indicator can use both percentages or points in its construction.
To construct the Zig-Zag indicator, there must be a certain percentage or number
of points between a swing high and a swing low before a line will be drawn. The
chart below of the E-mini Nasdaq 100 Futures contract visually illustrates the
difference between a price retracement Zig-Zag of 3% and a price retracement
Zig-Zag of 5%:
Notice how in the chart above that a Zig-Zag with a retracement percentage of 3%
makes more distinct lines than the Zig-Zag with a retracement percentage of 5%.
The purpose of using a Zig-Zag with a larger retracement percentage is to help
eliminate price noise that is not significant for the trader's analysis.
Zig-Zag indicator is extremely
effective at uncovering stock cycles while screening out short-term price
The Zig-Zag indicator is extremely effective in filtering short-term noise and identifying significant trends and significant changes in market prices.
Below is a chart of the E-mini S&P 500 Futures contract that illustrates
how effective the Zig-Zag indicator was in finding areas of support and resistance and price
The chart above of the e-mini uses a 5% Zig-Zag retracement value; therefore,
only price changes of 5% or greater are shown, helping a long-term trader or
investor determine important areas of support, resistance, and areas of price
On the left of the chart, the S&P 500 was forming a triangle consolidation pattern. When
prices broke resistance, a long-term buy was generated. During the middle of the
chart, the Zig-Zag indicator was effective in illustrating that the S&P 500
was in an upward price channel. Buying in areas where price touched the lower
support trendline and selling when prices touched the upper resistance line
would have proved extremely profitable.
Using the Zig-Zag indicator for shorter-term trades can prove profitable as
well. The chart below of Intel (INTC) shows a classic chart head and shoulder pattern
easily seen by the Zig-Zag indicator ($1 retracement):
The easily identified head and shoulders pattern gave a sell signal when price
on the right shoulder broke the upward slanting trendline.
The Zig-Zag indicator is an excellent technical analysis tool for identifying
classic charting patterns. The Zig-Zag indicator is also effective in reducing
noise and helping the technical trader see the true market direction.