ZigZag Breakout Strategy

The ZigZag indicator is primarily a tool used for trying to remove market noise and helping to visualize the actual progress a financial instrument has made from point A to point B. The ZigZag indicator software helps traders to visualize the highs and lows of price swings over the course of numerous timeframes. The ZigZag breakout strategy involves trading when price breaches the ZigZag indicators levels of support or resistance.

What is the ZigZag indicator?

The Zig Zag indicator is an indicator which identifies points on the price chart where price has significantly reversed. This is based on reversals that are greater than a certain percentage threshold. Straight lines are then drawn connecting these points creating a zigzag like structure.

By determining the support and resistance levels, the ZigZag indicator can help to identify significant changes in price while filtering out short-term fluctuations, thus eliminating some of the noise of everyday forex market conditions.

Because values for the ZigZag indicator are plotted only after the close of each time period, and because the ZigZag will only draw a permanent new line after price has moved significantly, it tends to be very much a lagging indicator.

The Zig Zag indicator is calculated by placing imaginary points on the chart when prices reverse by at least the specified amount. Straight lines are then drawn to connect these imaginary points. This online edition of Technical Analysis from A to Z is reproduced here with permission from the author and publisher.

The ZigZag indicator may look extremely similar to the Elliot wave theory for those who already know about it. The theory dictates that the chart pattern will contain five waves in the direction of the trend (impulse waves) and three against it (corrective waves). Moves in the direction of the trend are labelled 1-5, and those against it are labelled A, B, and C. Take the five-wave impulse sequence and combine it with a three-wave corrective sequence, and you have a complete Elliott Wave sequence.

How to trade with the ZigZag indicator?

The ZigZag indicator is a technical indicator that lowers the impact of random price fluctuations and is used to help identify price trends and changes in price trends. The ZigZag indicator plots points on the chart whenever prices reverse by a percentage greater than a pre-chosen variable.

The ZigZag indicator can identify tops and bottoms depending on the input settings used. Traders should be able to identify higher highs, higher lows, lower highs, and lower lows just by looking at the indicator lines

The ZigZag indicator shows when a currency pair trend could be reversing or breaking out, although you will still need to use other technical analysis and price action analysis to confirm entry and exit signals.

If the ZigZag line is being breached, you could confirm entry into the breakout using a trend trading indicator such as the ADX. If price is bouncing from the ZigZag indicator, then you could use an indicator to spot extreme overbought or oversold market conditions such as the RSI.

ZigZag breakout strategy buy signal

  • ZigZag indicator is showing strong resistance
  • Price breaches resistance level
  • ADX +DI is above the -DI
  • ADX is above 20 showing momentum
  • Bullish price action

In the GBP/USD 4-hour chart below, you will see that there was a strong level of resistance for the ZigZag breakout trade to the buy side. This was confirmed with the ADX +DI being above -DI showing an uptrend. The ADX above the 20 level also suggests this breakout trade into the trend is gaining momentum. We also have some bullish price action including inside bars and hammer formations. If we placed the stop loss just below the swing low, it would have been around 60 pips which is not too bad when you consider this uptrend reached around 500 pips at its peak.

ZigZag Breakout Strategy Buy Signal
ZigZag Breakout Strategy Buy Signal

ZigZag breakout strategy sell signal

  • ZigZag indicator is showing strong support
  • Price breaches support level
  • ADX -DI is above the +DI
  • ADX is above 20 showing momentum
  • Bearish price action

In the GBP/USD 4-hour chart below you can see that all of the above signals have been met. The ZigZag was showing a solid support level that was broken through with a big red candlestick. This downwards momentum was confirmed with the ADX crossover of the -DI above the +DI which indicates we are in a down trend. The ADX is also above 20 suggesting the trend has some momentum. There are also bearish candlestick patterns including three black crows. We could have placed the initial stop loss just above the ZigZag line which would have been around 50 pips. The price fell around 540 pips which gave ample opportunity for gaining a good number of pips. The high points of the ZigZag indicator on the way down could have been used as a trailing stop point to lock in profits. If you didn’t want to take the first ZigZag breakout entry, the price pulled back and bounced from the old support level to become resistance. This could have been another potential entry point into this downtrend.

ZigZag Breakout Strategy Sell Signal
ZigZag Breakout Strategy Sell Signal

ZigZag breakout strategy advantages

  • Trade breakouts and reversals
  • Can be used on any chart timeframe
  • Can be used on any currency pair
  • Automatically draws support/resistance levels
  • Easy to use and interpret the signals
  • Works with any other indicator

ZigZag breakout strategy disadvantages

  • Need to confirm the ZigZag signals
  • Not as reliable on lower chart timeframes
  • Not available by default in most platforms
  • Requires user initiative to time entry/exit

Conclusion: is the ZigZag breakout strategy any good?

Yes, I think the ZigZag breakout forex trading strategy can be a great way to get into some currency pair trends. The ZigZag indicator can be used to enter when price has a break out of a range bound market or to enter on an existing trend.

However, as with any forex strategy, success is likely to depend greatly on the traders forex money management and trading discipline. I have seen the exact same forex strategies give a completely different set of results due to these factors.

For instance, if you had a stop loss of 100 pips and a take profit of 20 pips, then one bad trade would cancel out 5 winners, not including broker fees. If you had a stop loss of 20 pips and take profit of 100 pips, then 1 winning trade could recover 5 losing trades not including fees.

If you like the look of the ZigZag breakout strategy, you could give it a try on a risk-free forex demo account which you can get from most forex brokers. This will allow you to practice your trading strategies and build some confidence. When you start getting consistent results, you may then consider switching over to a live account.