ZigZag Action Forex Trading Strategy

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ZigZag Action Forex Trading Strategy

Price Action – this is what you would often hear among traders nowadays. Many profess to its greatness while many mumbles regarding it without really knowing what it is.

Price action basically refers to the movement of price as it is plotted on a chart. It is a school of thought among technical traders wherein traders try to read market condition and behavior based on how price is moving on the chart and would try to predict future price movement based on it.

In a way, price action encompasses a huge body of technical trading and is approached by traders in many ways. Some would use candlestick patterns to assess the market, some would read the market structure through market flow, others would observe price patterns, others would find supports and resistances, some would look for retests on breakouts, and traders have many more ways to read the market through price movement and they also call it price action. This speaks of how broad price action trading is.

Defining Trend Through Price Action Swings

Perhaps one of the most overlooked approach to price action is on how to define the trend based on price swings. Often traders would look at a chart and subjectively look at how tilted price movement is and make it as a basis if the chart is trending and which way it is going. For a clearly trending chart that would be fine, but that is not an objective assessment of a trend. You can’t just look at a chart and blurt out the direction you think it is going based on how tilted the movement is.

So, how do we assess trend the price action way?

Price movements tend to gyrate up and down as it moves along the chart. This causes peaks and troughs to be printed throughout the chart or more technically known as swing highs and lows. These swing highs vary in depth and height in relation to the previous highs and lows. This variance is how we should determine whether price is trending or not.

If price is constantly making new highs or higher highs, while also constantly making higher lows, then the chart is in an uptrend. On the other hand, if price is making new lows or lower lows while making lower highs, then the market is on a downtrend. If price is going all over the place, making new highs then making lower lows, or vice versa, then the chart is just not trending.

Many who have mastered the art of determining trend through price action have profited from it. However, learning this technique requires a lot of practice and a whole lot more of screen time.

Trading Strategy Concept

Knowing that determining trend through swing highs and lows is an effective way of trading the market, we will try to replicate this method, but with training wheels for those who are new to this method. Because determining the swings is quite difficult, we will be using an often-overlooked indicator, which allows traders to visually determine if the chart is trending or not. We will be using the ZigZag indicator as a basis for our swing highs and lows.

If we determine that the market is forming higher highs and lows, and is therefore on an uptrend, on the pullback, we will be looking for bullish candlestick patterns. If the market is forming lower highs and lows, and is therefore on a downtrend, then we will be looking for bearish candlestick patterns. These reversal patterns will be our entry signals.

Because the ZigZag indicator is dynamic, the last line usually shifts as price moves along. So, we will not be waiting for it to pinpoint the last high or low as our entry. We will be entering as soon as a reversal candlestick pattern forms. This would usually coincide with a new swing high or low, which is often confirmed a few candles after the entry.

Indicator

  • 25 EMA: Green
  • 50 EMA: Brown
  • Zigzag: Depth – 5

Timeframe: 5-minute chart and above

Currency Pair: any

Session: any if not day trading

Buy (Long) Trading Setup Rules

Entry

  • 25 EMA should be above 50 EMA
  • Price should be forming higher highs and higher lows
  • Wait for a bullish reversal candlestick pattern to form (pin bar, engulfing pattern, piercing pattern, etc.)
  • At the close of the bullish reversal candlestick pattern, enter a buy market order

Stop Loss

  • Set the stop loss at the swing low below the entry candle

Take Profit

  • Set the target take profit at 2x the risk on the stop loss

zigzag action forex trading strategy 01

zigzag action forex trading strategy 02

Sell (Short) Trading Setup Rules

Entry

  • 25 EMA should be below 50 EMA
  • Price should be forming lower lows and lower highs
  • Wait for a bearish reversal candlestick pattern to form (pin bar, engulfing pattern, piercing pattern, etc.)
  • At the close of the bearish reversal candlestick pattern, enter a sell market order

Stop Loss

  • Set the stop loss at the swing high above the entry candle

Take Profit

  • Set the target take profit at 2x the risk on the stop loss

zigzag action forex trading strategy 03

zigzag action forex trading strategy 04

The second sell sample chart would have been questionable to naked chart price action traders. This is because the real initial high was the spike after the high indicated by the ZigZag indicator. This is normal because price action trading is naturally subjective and is therefore in need of a human assessment. The ZigZag indicator is just there to assist us. It doesn’t mean that we follow it blindly. However, on this chart, whether it was the ZigZag’s high or the spike that was used to determine the initial high, it would have worked either way.

On both sell samples, there were also succeeding trading setups that would have worked. One is a bearish engulfing while the second is a piercing pattern.

Conclusion

This is a working strategy used by price action traders. The only difference is that they often use naked charts. Meaning there are no moving averages and ZigZag indicators to assist us in determining the trend. As you master price action trading, you could start removing these training wheels. But I think there is no added incentive in doing this as going on a naked chart doesn’t necessarily improve trading. It only adds to your bragging rights knowing that you could determine trend without the aid of indicators. Maybe the advantage would be that there are less noise and contradicting information from the indicators and what you know as a price action trader as a swing high or low.

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