What it means
Price charts for shares, currencies and commodities are full of small movements that can hide the bigger picture. The Zig Zag indicator solves this by setting a minimum percentage move, such as 5%.
It plots a new turning point only when the price reverses by at least that amount from its last high or low. The result is a line that connects the major peaks and troughs.
A trader can see at a glance whether the market is making higher highs and higher lows, which suggests an uptrend, or lower highs and lower lows, which suggests a downtrend. It also makes it easier to measure the size of past swings.
The indicator is used for several tasks. Analysts use it to count waves in pattern analysis, to place support and resistance levels, and to measure how far prices typically move before reversing.
Companies with commodity exposure sometimes use it as a simple way to describe past price cycles. The big nuance is that the latest leg of the line can change.
Because a turning point is only confirmed after the price reverses by the threshold amount, the final segment moves as new prices arrive, which is known as repainting. That means it is a description of the past and should not be used on its own as a buy or sell signal.
The choice of threshold matters. A small threshold gives many swings and little filtering, while a large one shows only the biggest moves and may ignore useful turns.
Users test different settings and combine the indicator with others, such as moving averages and volume. For non-traders, the indicator is a handy way to describe price history in plain terms.
A procurement manager can say that the last three rises in an input price averaged 18% over four months, and then compare that with the current move. The figures give a business a calmer way to talk about price cycles than a busy chart does.
In practice
Real-world examples.
Example
A share trader applies a 5% Zig Zag to a stock chart and sees four clear swings in a year. She notes that each rally lasted about three months and gained about 20%. She uses the pattern to plan when to review her position.
Example
A commodity analyst for a food manufacturer uses a 10% Zig Zag on wheat prices. The chart shows that major rises tend to last about four months before pulling back. He uses it in a presentation to explain the buying schedule.
Example
A currency analyst uses the indicator to mark swing highs and lows on a euro chart. She places stop orders just beyond the last confirmed low. The method keeps her from reacting to small daily moves.
Formula
Calculation
Reversal % = (Last extreme price - Current price) / Last extreme price x 100, for a fall from a high
A threshold of 5% is set. The price rises from $100 to a high of $112. It then falls to $104, so the reversal is (112 - 104) / 112 x 100 = 8 / 112 x 100 = 7.14%. Because 7.14% is above the 5% threshold, the high at $112 is confirmed as a turning point and the line is drawn down to the new low.Case study
Seen in the real world.
Kingsford Metals is an illustrative, fictional manufacturer that buys 1,000 tonnes of aluminium a quarter. The purchasing manager uses a 6% Zig Zag on historical prices to see how long price cycles last. The chart shows that rallies typically peak after about five months.
She uses the information to time forward purchases. When prices have risen for four months, she buys cover for the next six months, expecting a pullback. In the illustrative year, this saves the company about 4% on $2,400,000 of purchases, which is 2,400,000 x 0.04 = $96,000.
The lesson is that the Zig Zag indicator describes patterns but does not predict the future. Kingsford keeps a rule that no single purchase exceeds 30% of the annual need. The manager reviews the threshold each year, because a change in market conditions can make an old setting less useful.
Watch out
Common mistakes.
- Using it as a standalone buy or sell signal, when its last line segment can change as new prices arrive.
- Choosing a threshold without testing, when a poor setting hides real swings or shows too many.
- Assuming past swings will repeat exactly, when markets change and patterns do not always recur.
Questions
People also ask.
What does the percentage setting do?
It sets the minimum reversal needed to confirm a new turning point and draw a new line segment.
Is it a leading indicator?
No, it is based on past prices and confirms turning points only after they have happened.
Where is it used?
Share, currency and commodity charts, often with wave analysis, support and resistance, and trend assessment.
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