Despite being a less popular trading tool than RSI or MACD, Alligator indicator presents a unique combination of several instruments and allows traders to take an in-depth look at the market. In this comprehensive guide, we will explain what it is, how to calculate the alligator indicator and interpret it for managing your trades efficiently.
What Is the Williams Alligator Indicator?
70-80% of the trading day, most assets keep moving in a sideways range, and only 20-30% of the time, there are strong and directional movements when traders can make a profit. The major challenge for market participants is to determine the moment when the trend starts because any technical indicator has a delay which cannot be completely eliminated.
One of the solutions to this problem is the Alligator indicator developed by Bill Williams, a prominent trader. Alligator Indicator is proved to be efficient even in modern conditions of high-frequency (HFT) trading.
The alligator indicator serves to determine the moments of the flat, to give signals of the beginning and end of the current trend. From a technical point of view, this is a set of moving averages shifted forward relative to the current price by a certain number of bars. Thus, the indicator helps traders predict the future movement in the medium and long term, but with speculative actions and increased volatility, the quality of the signals drops sharply.
How Does the Alligator Indicator Work?
An ‘alligator’ is composed of three moving averages: a blue line is the jaw, a red line is the teeth and the green line is the lips. Note that those are default colors and they can be customized on a Forex trading terminal.
To understand how the alligator indicator works, we can apply a simple analogy:
- "Sleep". The moving averages move horizontally, they are highly intertwined and represent a tight price range around the red MA with no trading signals. The longer the flat lasts, the greater the “hungry” indicator, the stronger and longer the new market movement.
- "Awakening". The “fast” average - Alligators Lips (green) - is the first to react to an increase in market activity, showing the most likely direction of a new trend. Experienced traders dare to open a deal already at the moment of its crossing by the price, but it is better to wait and make sure that the lines are in the correct position relative to each other and increase the distance between them (the Alligator goes “hunting”).
- "Opening the mouth". Continued support of the current movement by new participants and volumes, which confirms the reaction of the Alligators Teeth red line, and the “slow” blue (Alligators Jaw) completes the formation of the figure.
- "Falling asleep". When the trend ends, the lines begin to intersect again and go horizontally (the alligator is “sated”). Here, it is recommended to close current positions regardless of the level of current profit/loss.
During the entire trend, the lines of the Alligator indicator should be arranged in a strict order: green - red - blue. It is necessary to open after the price crosses all three MAs, enter on the rebound from Alligators Teeth only after additional confirmation. In the final stage, a reverse intersection is observed, but in the same order.
How To Calculate Williams Alligator
The Alligator indicator is calculated by the following formula:
SUM1 = SUM (CLOSE, N)
SMMA1 = SUM1/N
PREVSUM = SMMA(i-1) *N
SMMA(i) = (PREVSUM-SMMA(i-1)+CLOSE(i))/N
SUM1 = sum of price closes during N period
N = smoothing period
SMMA1 = smoothed moving average of the first bar
PREVSUM – smoothed sum of the previous bar
SMMA(i) = smoothed moving average of current bar
CLOSE(i) = current price close
Since the calculation process is complicated, using trading software with automated tools makes sense. The majority of trading platforms and terminals include Alligator indicator - all you need is to activate it and customize settings, if necessary.
How to Read the Williams Alligator
Before you start using the indicator to search for trend changes, you should remember that 70-80% of the time, the market is moving sideways.
The Absence of a Trend
This is a common state of the market that is observed when the three lines of the Alligator indicator move close to each other or are intertwined. In other words, the Alligator is sleeping and waiting for alterations in market conditions.
Formation and Development of a Trend
When the green line starts to cross, the alligator is getting hungry and ready to eat - this is when you should search for a trading opportunity. After that, the red line (teeth) starts separating and moves in the same direction. When the green and red line pull away from the blue line, Alligator opens its mouth and starts eating. At this very point, a trader should take a price action.
How to distinguish between uptrend and downtrend?
- When the green and the red line are crossing to the upside, this is a bullish alligator - consider making long trades.
- When the green and the red line are crossing to the downside, this is a bearish alligator, so it’s time to short.
What Are The Advantages of Using The Alligator Indicator?
There are several reasons to include the Alligator Indicator into your trading strategy:
- You don’t need to calculate it manually - the indicator is often included in trading terminals.
- It allows traders to identify the situation on the market, especially reversals and divergences. The indicator is always activated during the period of trend change.
- It shows the right entry points when the momentum is only appearing. Hence, traders can open and close positions with maximum efficiency.
- This tool is derived from the moving average, one of the most reliable and efficient indicators on the market.
- It can be easily combined with other indicators.
What Are The Limitations of Using the Alligator Indicator?
- The major downside of the alligator indicator is that it cannot be equally useful all the time - this indicator won’t help you during a sideways market.
- Signals generated by this indicator cannot be 100% correct, so this trading instrument should be coupled with other tools.
Alligator Indicator Strategies
The alligator indicator can be applied in different conditions and trading strategies. Before we start observing them, it should be noted that this trading tool proves to be useful only during trending markets. When the asset keeps moving sideways, the alligator is ‘sleeping’.
Trading Ranges and Breakouts
When there’s no pronounced trend, the market is range bound - this is when you can apply this strategy to make early entries. Note that during trend transition when the market is consolidating any indicator may generate false signals.
As you can see on the chart, three lines are intertwined and the asset price shows the same highs and lows. When you see the alligator awakening, you can also notice a trend change - this is the time for entry. This is a classic breakout trade when the spacing of the Alligator lines is supporting your trade.
Trading Pullbacks In Price
When you see the lines going in a certain direction, you can introduce a price pattern that’s commonly used by many traders - a pullback. To support your theory, you should have all lines pointed in a single direction. The example below shows that the trend is underway. You can define the length of pullback by selecting where the price should pull back to.
On the chart, you can see the pullbacks to the green line. While the yellow pullback line gets longer, the Alligator is opening its mouth - the distance between moving averages keeps increasing. On the right side, we see the trend reversing finally.
Alligator Line Cross
The simplest approach to trading the Alligator is making deals when the candlestick closes after crossing the lines. In this case, you should also look at support and resistance levels to make sure that the buy and sell signals are correct - they should be related to the current cluster of the price, not the previous one.
With the Line Cross strategy, rules can boil down to two points:
- A BUY signal comes when the price breaks all moving averages and closes above them. The lines are directed upwards and point to the Alligator Lips.
- A SELL signal comes when the price breaks the Alligator indicator from top to bottom, the last 2-3 candles are closed below the intersection point. Averages pointing down to the Alligator Jaw.
Take a look at the chart: the green line has crossed over the red one to the upside. Lines intertwined before the green candlestick we are watching. What to do in such a situation? You can go long after the candlestick closes above all three lines and then watch the alligator’s behavior. When it comes to the stop loss, consider using the average true range or previous highs and lows.
Tips for Traders Using Alligator Indicator
Before you practice trading with the alligator indicator, there are a few points you should be aware of.
- During the lateral market movement, it is not safe to conclude transactions - the indicator may generate false signals.
- When you trade during trending markets, the volatility range will be the distance between the green and blue lines, the angle of inclination can be used to assess the strength of the trend.
- Using Stop Loss is essential regardless of the type of strategies and additional tools!
Using Alligator’s lines
Depending on the trading goals and the most comfortable trading style for the trader, different averages will be of key importance for entering the market and placing Take Profit/Stop Loss orders.
Setting Stop Loss on the indicator lines
The Alligator indicator does not come with recommendations on the size of Take Profit, everything is determined individually. When you set Stop Loss, it is recommended to follow a few rules:
- Placing Stop Loss behind the Alligator’s Jaw line makes the position more resistant to random and speculative price impulses, but increases the risk, since the price already transfers the deal to a critical level of losses when approaching the line.
- Stop Loss in the area of the fast average (Alligator’s Lips) often leads to quick closes on small corrections and rollbacks after which the trend resumes.
- Ideally, you should divide the trade volume into 3 equal parts: stop for the 1st part is behind the Alligator’s Jaw line, the 2nd one is behind Alligator’s Teeth, and complete closure of the position when Alligator’s Lips are broken. With this approach, you can use the instrument not only to profit from a short-term impulse, but also as a timely exit signal when it ends.
How to use the Alligator indicator with standard tools?
The basic principle of building trading strategies is to use instruments from different groups - thus they will confirm each other’s signals. As an example, you can take the following combination in addition to the Alligator:
- Fractals indicator with default parameters;
- Simple moving average (SMA) with a period of 233;
- Overbought/oversold oscillator Stochastic (11,3,3).
Parameters may change upward during periods of high volatility.
First of all, you should not open deals if the fractal is formed above or below the Alligator indicator - this indicates that the price has completely left the moving average range and the technical rollback is completed. We also stay out of the market when the fractals are in the weave zone.
Here’s how you can execute your strategy:
- Set a pending order Buy Stop for purchases and Sell Stop for sales 2-3 points above/below the current price, when the price crossed the level of the last fractal for the second time after the rollback.
- Then you can move in the direction of the trend, opening additional deals on new fractals (up only buys, down only sales).
- By using a “long” SMA, you can quickly determine a long-term trend: the price is higher - ascending, lower - descending, moving horizontally - flat.
- Fractal signals are filtered out by Stochastic: downlines after a reversal at the level of 70/80 confirm a sale, up from 20/30 a purchase.
As a trend determinant, the Alligator indicator can be included in a strategy with any entry method. For example, you can open using a fast line, and take profit on two other slow ones. Or close deals on opposite signals from other indicators, such as MACD or the Stochastic.
The main drawback is Williams’ decision to use moving averages, which are the most lagging technical tool. But when you operate more or less stable markets, such as gold or currency pairs, such a tool is justified. Finally, remember that when signals are confirmed by oscillators on higher time frames from H1 and above, the Alligator indicator allows you to confidently predict the trend in many cases.