ZigZag Fibonacci – Strategy And Rules
The financial markets may seem random in the way they move, but with certain technical analysis tools, like the Zigzag Fibonacci, you might find that the movements follow a certain pattern. What do you know about the Zigzag Fibonacci?
In trading, the Zigzag Fibonacci indicator is a unique analysis tool that combines two commonly used technical tools — the Fibonacci retracement tool and the Zigzag indicator — to help spot potential price swing points. While the Zigzag indicator shows prior price swing points, the Fibonacci retracement tool part of the indicator helps show potential reversal levels where the current price swing might turn.
In this post, we will take a look at most of the questions you may have about this indicator: what it is, how it works, and how you can improve your trading strategies with it. Read along!
Key takeaways
- ZigZag Fibonacci uses two tool: the ZigZag indicator and Fibonacci retracements.
- The Zigzag indicator aspect of the tool shows previous price swing points, which makes it easy to visualize the price trend and structure.
- The Fibonacci retracement tool part of the indicator helps show potential reversal levels where the current price swing might turn based on the usual Fibonacci levels.
- We cover all trading indicators – this article is just one of many.
What is the Zigzag Fibonacci indicator in trading?
In trading, the Zigzag Fibonacci indicator is a unique analysis tool that combines two commonly used technical tools — the Fibonacci retracement tool and the Zigzag indicator — to help spot potential price swing points. It is a hybrid indicator that tries to use the qualities of two well-known tools to improve market analysis.
The Zigzag indicator aspect of the tool shows previous price swing points, which makes it easy to visualize the price trend and structure. On the other hand, the Fibonacci retracement tool part of the indicator helps show potential reversal levels where the current price swing might turn based on the usual Fibonacci levels.
As you may already know, the Fibonacci retracement levels are certain percentage levels of the previous price swing that are believed to act as support/resistance levels when the price retraces to them. So, the combination of the Zigzag indicator and the Fibonacci tool helps to clearly show the previous price swings and project levels where the next swing might end so traders can look for reversal setups at such levels.
ZigZag Fibonacci trading strategy and trading rules
Because the ZigZag indicator has an in-built look-ahead bias, we can’t backtest it.
How does the Zigzag pattern help in technical analysis?
The Zigzag pattern helps in technical analysis by showing the previous price swing points, which makes it easy to visualize the price trend and market structure. It focuses on major price swing points and thus, filters out minor swings that may constitute market noise.
Although it is a lagging indicator, as it can neither tell the end of a price swing in real time — in fact, it sometimes repaints the swings points — nor predict reversal levels, it can help traders get a broad view of the market trend and price structure based on previous price action. Traders use it to study market trends, price structure, and price swings.
What are Fibonacci retracement levels?
Fibonacci retracement levels are horizontal lines plotted on the chart at certain percentage retracements of the previous price swing, which are based on Fibonacci ratios, to represent potential levels where the retracing price (pullback) might reverse. Thus, depending on the direction of the previous price swing, the Fibonacci retracement levels may act as possible support or resistance levels.
If the previous swing is an upward swing, the retracement levels act as support levels, where a downward pullback can reverse to continue an uptrend. If the previous swing is a downswing, the retracement levels act as resistance levels where a price rally can reverse for the downtrend to continue.
How do you apply Fibonacci retracement in a chart?
To apply the Fibonacci retracement tool in a chart, you have to know the price swing you want to attach it to, its direction, and where the swing started. Next, you pick the tool and click first at the starting (lowest/highest) point of the price swing and extend it to the end of the swing (highest/lowest point). then, the tool automatically calculates the percentage levels and plots horizontal lines there — common levels are 23.6%, 38.2%, 50.0%, 61.8%, 78.6%, and so on. See the chart below:
What does the Zigzag Fibonacci indicate about market trends?
The Zigzag Fibonacci indicates the potential price swing points in market trends. In other words, it indicates where to anticipate a pullback reversal in a trending market.
The indicator combines the qualities of the zigzag indicator and the Fibonacci retracement tool to show where the next price swing point or reversal level might be. This is very helpful in a trending market where traders want to know where a pullback will end so they can trade the next swing in the market trend.
How can Zigzag Fibonacci improve trading decisions?
The Zigzag Fibonacci indicator can improve your trading decision by showing you the structure of the market, how the market is moving, the direction it is moving, and the potential reversal levels to anticipate price reversals. With this information, you can look for price reversal candle patterns or momentum oscillator reversal signals when the price gets to the anticipated level. You can build a trading strategy on this, and the price swing points can also guide your stop-loss levels and profit targets.
What are the common settings for the Zigzag Fibonacci indicator?
The common settings for the Zigzag Fibonacci indicator are the same common settings for the individual indicators — for the Zigzag indicator, they are 10-period or 12-period depth, 5% deviation, and 3 backsteps; while for the Fibonacci retracement tool, they are the 23.6%, 38.2%, 50.0%, 61.8%, and 78.6% levels.
However, you can change the setting to what you want based on what you have noticed to work for your strategy in the market you are trading.
How do traders identify support and resistance with Zigzag Fibonacci?
Traders can identify support and resistance levels with the Zigzag Fibonacci indicator by marking the levels of the price swing points identified by the Zigzag aspect of the indicators. Those are levels where the price has already reversed from in the past, so there are chances that the price may reverse from such levels again.
Also, the Fibonacci retracement part of the indicator shows potential support and resistance levels where the price may reverse from next.
What time frames work best with Zigzag Fibonacci analysis?
The time frames that work best with Zigzag Fibonacci analysis will depend on your trading style and strategy. If you’re a day trader, you may want to use an intraday time frame, such as the hourly 30-minute, or 15-minute time frame. But if you are a swing trader, higher timeframes like the 4-hourly and daily timeframes would concern you more.
However, for whatever style of trading you are using, the easiest way to know the best time frame is to backtest different timeframes and choose the one that works best.
How does the Zigzag Fibonacci relate to market volatility?
How the Zigzag Fibonacci relates to market volatility will depend on the indicator settings and whether the market is trending or not. If the market is trending, it means the price is advancing in one direction, albeit with huge and more frequent swings. In this case, the indicator can easily show the price swing points and the Fibonacci levels more frequently, potentially offering more trading opportunities.
However, if the price is stuck in a range, the indicator settings will determine whether it will produce multiple unreliable signals within the range or accommodate the range in one swing move.
Can Zigzag Fibonacci be used for all types of markets?
Yes, the Zigzag Fibonacci indicator can be used for all types of markets because it focuses on price data alone, which is easily available for all types of financial markets.
It will be a different story if the indicator makes use of the volume data, which is not available for some markets that are not traded on a central exchange, such as the spot forex market.
How do beginners set up the Zigzag Fibonacci indicator?
For beginners to set up the Zigzag Fibonacci indicator, they have to find a custom-made indicator for the platform they are using to trade, as the indicator is not one of the built-in indicators that come with most trading platforms.
After installing the custom indicator on their platforms, they can go to the indicator section of the platform and double-click on it or grab and drop it on their charts. If they can’t find a custom indicator for their platforms, they can set up with both individual tools — the Zigzag indicator and the Fibonacci retracement tool.
What are the pitfalls of relying solely on Zigzag Fibonacci?
The pitfalls of relying solely on Zigzag Fibonacci include the following:
- It could lead to frequent losses, as previous swing points and Fibonacci levels don’t tell you whether the price will reverse at any level or not.
- You may trade against the direction of the main trend — without at least a proper analysis of the price swings with the help of a trendline, you can miss the trend direction.
How do Fibonacci levels predict market reversals?
Fibonacci levels predict market reversals by measuring and marking certain percentage levels from the previous swing where the price could reverse during a pullback. Those percentage levels are based on Fibonacci ratios, which are often seen in many aspects of nature.
The common Fibonacci retracement levels are the 23.6%, 38.2%, 50.0%, 61.8%, 78.6%, and 100% levels. At the 100% level, it means the price retraced all the movement of the previous swing.
What role does psychology play in Fibonacci trading strategies?
Psychology plays a big role in Fibonacci trading strategies since it’s market participants’ beliefs in the Fibonacci levels that give them their trading effects. The Fibonacci levels function like a self-fulfilling prophecy.
Because the market players agree that there is something special about the Fibonacci levels, as they are based on Fibonacci ratios, traders place their orders around the levels, and when the price gets to any of the levels, more orders come in, increasing the tendency of a price reversal at the level.
How accurate is the Zigzag Fibonacci in forecasting?
The Zigzag Fibonacci can be accurate in forecasting, but as with any other indicator, it cannot be accurate all the time. Sometimes, it predicts price reversal levels with pinpoint accuracy, but at other times, which unfortunately is the majority of the time, it is off the mark.
A typical problem with the Zigzag Fibonacci is that you cannot tell which Fibonacci level the price will reverse from.
What complementary indicators work well with Zigzag Fibonacci?
Complementary indicators that work well with Zigzag Fibonacci are medium or long-period moving average indicators, trendlines, and support and resistance level indicators.
Trendlines and long-period moving average indicators can help identify the direction of the main trend, while the support and resistance level indicators can mark out previous support/resistance levels which can form confluences with the Fibonacci levels of the Zigzag Fibonacci indicator.
How do economic events impact Fibonacci and Zigzag patterns?
Economic events impact Fibonacci and Zigzag patterns by affecting market volatility, price movements, and price swing sizes. But more importantly, high-impact economic events can cause huge price movements that do not respect the market Fibonacci levels or previous swing points.
While the zigzag and Fibonacci tools are mostly used for reversal trading, high-impact economic events tend to generate breakouts.
What are the differences between Zigzag Fibonacci and other Fibonacci tools?
The differences between Zigzag Fibonacci and other Fibonacci tools are as follows:
- The Zigzag Fibonacci indicator is based on the Zigzag indicator and the Fibonacci retracement tool, while Fibonacci tools could be the Fibonacci expansion tool, Fibonacci time zones, Fibonacci arcs, and so on.
- The Zigzag Fibonacci uses zigzag to clearly show previous price swings where the Fibonacci retracement tool is applied, while other Fibonacci tools don’t clearly show how they get their values.
How do you interpret conflicting signals from Zigzag Fibonacci?
To interpret conflicting signals from Zigzag Fibonacci, you have to use other indicators or analysis tools to decipher the right direction of the market to know which one could be the right signal. For instance, if the market is showing conflicting swing points, the best thing to do is to use a long-period moving average or do a price action analysis on a higher timeframe to find the direction of the main trend.
What are the best practices for combining Zigzag and Fibonacci?
The best practices for combining Zigzag and Fibonacci include:
- Trading only in the direction of the main trend
- Setting the indicator to only use the major price swing points
- Not placing limit orders on projected reversal levels
- Using reversal candlestick patterns or momentum oscillators to determine when to enter a trade
- Having a clear risk management plan
How can algorithmic trading utilize Zigzag Fibonacci?
Yes, algorithmic trading can utilize Zigzag Fibonacci, but it will be more difficult to code the trading logic than it is with simpler indicators. The indicator combines two complex trading tools, and the trade entry rules — reversal candle pattern — all contribute to the difficulty in coding a trading algo for it.
Moreover, the Zigzag swing points often change as the indicator repaints based on what the price does after forming the initial fractal.
What historical data is most relevant for Zigzag Fibonacci analysis?
The historical data that is most relevant for Zigzag Fibonacci analysis is the price data. Both the Zigzag and the Fibonacci retracement level aspects of the indicator are based on price action — the Zigzag indicator marks the previous price swings, while the Fibonacci retracement tool estimates the retracement levels the price could get to and reverse to form the next swing point.
How often should traders adjust the settings of Zigzag Fibonacci?
How often traders should adjust the settings of Zigzag Fibonacci will depend on their trading strategies, the timeframes they trade on, the markets they trade, and the prevailing market conditions. All the mentioned factors can affect how the indicator performs, which is what determines whether to adjust it or not. However, to know the settings to use at any point, they will have to backtest and base their decisions on their backtesting results.
What are the limitations of technical indicators like Zigzag Fibonacci?
The limitations of technical indicators like Zigzag Fibonacci are as follows:
- They cannot tell whether the price will reverse at the projected level or not.
- They try to use what the market has done in the past to predict future price action, which may not always work.
- They can repaint depending on what the price does after forming the initial mini fractal.
How does one test the effectiveness of a Zigzag Fibonacci strategy?
To test the effectiveness of a Zigzag Fibonacci strategy, one has to backtest the strategy across different markets and timeframes.
Backtesting it on different markets allows one to know the markets where the strategy performs well, while testing it across different timeframes helps to show the best timeframe to trade the strategy.
What are the latest developments in Zigzag Fibonacci tools?
The latest developments in Zigzag Fibonacci tools are algorithmic trading and portfolio management. With algorithmic trading, traders try to automate their Zigzag Fibonacci trading strategies using trading algos that follow the logic of the indicator and their strategies.
In portfolio management, traders may use the indicator to spot markets that are approaching reversal levels so they can position to take advantage of the reversal when it happens.
How do traders handle false signals from Zigzag Fibonacci?
To handle false signals from Zigzag Fibonacci, traders have to analyze the signals in the light of the direction of the main trend. Signals that are against the main trend directions should be avoided. Only signals in the trend direction should be taken.
Also, traders should have entry triggers, such as reversal candle stick patterns that show when the price has reversed.
Can Zigzag Fibonacci be applied in short-term trading?
Yes, Zigzag Fibonacci be applied in short-term trading, as what determines how you apply the indicator is your trading style and strategy. If you prefer short-term trading, you can apply the indicator on lower timeframes that suit your trading style. You must backtest your strategy to be sure it works well before you commit your money.
What risk management techniques pair well with Zigzag Fibonacci?
The risk management techniques that pair well with Zigzag Fibonacci are the use of stop-loss orders and limiting your position sizes to what allows you to risk only about 1% of your account size per trade. Interestingly, both the Zigzag swing points and higher Fibonacci retracement levels can guide where you place your stop-loss orders.