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Are zig-zag indicators any good?

Trading Strategies

Are zig-zag indicators any good?

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Whenever the question of indicator-accuracy raises its inquiring, bespectacled head amongst the global fraternity of bruised, battered and sceptical forex traders there is rarely a definitive consensus. The ‘Zig Zag’ indicator is certainly no exception to this with its Marmite ability to divide opinion and invoke contentious exchanges as to its usefulness as a forex trading indicator.

The fact is, accuracy can only really be measured if there is an agreement on what is required to be accurate. In the case of the Zig Zag, its variety of applications to forex trading may well be its downfall and many are quick to disregard it as something that looks great in hindsight but has limited application when it comes to real-time trading. For many traders the Zig Zag is simply used as an analytical tool to remove the ‘noise’ of the market. By simplifying swings between price points it is helpful in showing the overall direction of the trend and the meaningful quality of retracements. This allows longer-term traders to stay in positions that they may otherwise have closed with the small consolidations and minor reversals in large price moves. It also allows traders to clearly identify popular trading patterns such as flags and pennants, as well as being incredibly useful for Elliot wave traders. In this sense the standard Zig Zag is not a particularly accurate indicator of future price movements but is a useful supporting tool to which we can apply more predictive analysis and confirmation indicators.

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For short term traders the Zig Zag may appear useless if simply taken as a signal to enter a trade with each change of direction. This is because it is a lagging indicator and suffers from the same delay in real time as Moving Averages and MACD. It will begin to point in the new direction after, rather than during, a movement in price. Using the customisable setting of 5% the indicator will only draw a new line once price has changed direction by more than this degree. It uses three-bar fractals (this is where a bar has a lower low or higher high than both the bar before and after it) to define the points where it may change direction. The Zig Zag therefore always has the potential to ‘repaint’ on the close of the current bar on any timeframe and only the values three bars in the past can be considered static using this version.

 A market may be below the 5% threshold for several bars and then close above causing the chart to take on a delayed change in appearance. These sharp alterations in direction give the Zig Zag its shape and, without this required delay and repaint, it simply wouldn’t be a Zig Zag. The problem for the short-term trader looking for an entry or exit signal is that a previously considered down-trend would now appear to indicate a delayed reversal and usually several bars after the price had begun to move.

Non-repainting Zig Zag indicators claim to provide an accurate, real time reflection of price without the repainting of historical date. These cannot be considered Zig Zag indicators in the true sense, and often the code within the indicator may simply ignore the most recent three bars of data to appear static. The High Low Zig Zag indicator, for example, only operates on charts which define the high, low, open and close (i.e. candlestick charts rather than line charts) and takes the high and low of the last bar rather than the close value in order to determine if line will be drawn in a new direction. If the high or low breaks the percentage threshold a new line will be drawn irrespective of whether the close is beyond this. This version can be considered non repainting if the price hits the threshold for a new line, however, its accuracy at predicting future price movements is equally limited when this final bar remains open without hitting the threshold and with the potential to continue or change the direction of the Zig Zag.

Alongside the many variations of the Zig Zag claiming to provide greater accuracy without repainting are those which combine the Zig Zag and alongside other indicators such as the GANN zigzag indicator. This swing trading indicator attempts to give the Zig Zag another dimension by adding a non-lagging, prediction of trend changes which can be combined to emphasise when Zig Zag direction changes may be valid. Despite these combinations, the definition of accuracy in the context of the standalone Zig Zag indicator is still highly subjective. As an accurate predictor of future price movements it will fail miserably regardless of whether it repaints or not. On the other hand, as an accurate projection of the previous bias of a market it will pinpoint highs, lows and trends with the utmost accuracy.

Tristan Goldthorpe currently lives in Madrid working for an international private sector development consultancy. He completed a postgraduate degree in London two years ago and has since been studying, trading and writing about politics, economics and the forex markets in his spare time. His particular interests are the use of support and resistance to determine price movements and the tendency for markets to become over-extended. Over the past few years he has researched and experimented with different techniques and strategies and now enjoys analysing and discussing potential trade opportunities and fundamental economics.