ALLIGATOR

Alligator
Technical Indicator
Alligator
Alligator
INTRODUCTION AND HISTORY

Bill Williams introduced the Alligator indicator in 1995. The Alligator is as much a metaphor as it is an indicator. It consists of three lines, overlaid on a pricing chart, that represent the jaw, the teeth and the lips of the beast, and was created to help the trader confirm the presence of a trend and its direction. The Alligator indicator can also help traders designate impulse and corrective wave formations, but the tool works best when combined with a momentum indicator.

The “traits” of the Alligator are numerous. If the three lines are entwined, then the Alligator’s mouth is closed and he is said to be sleeping. As he sleeps, he gets hungrier by the minute, waiting for a breakout from his slumber when he will eat. When the trend takes shape, the Alligator wakes and starts eating. Once satiated, the Alligator closes his mouth once again and goes to sleep.

The alligator indicator of forex trading became widely popular after his publications “Trading Chaos” and “New Trading Directions” had emerged. In this article, we will investigate the key specificities of the alligator index, and will explain the particularities of trading with alligator.

Bill Williams — The mind behind the alligator indicator

Bill Williams is a well-known trader in the world of forex and futures and stocks. He is also an analyst and has done some extensive research in the markets. Williams’ main point was that the markets are unpredictable. This formed the basis of his creation of various technical indicators.

According to Williams, he believed that many trading systems fail because they rely on the predictability of the trends. He maintains that a good trading system is one which can predict the unknow.

After designing numerous trading indicators, Williams created the alligator indicator which reflects this same philosophy. Therefore, traders should not view the alligator indicator as something that works similar to other indicators.

One of the main things about Williams’ approach to the markets was not to complicate trading. His main basis has been that the markets are simple. But in order to succeed a trader often tends to complicate their trading systems by adding numerous indicators and thus creating a complex system.

As you might know, technical analysis is all about understanding past price action in order to predict future price behavior.

When it comes to Bill Williams, it was a contrarian approach. Williams’ view of technical analysis was to look at the current behavior of the markets. This is one of things that is aptly reflected in his trading system. This is also one of factors that makes the alligator indicator so unique.

Definition:

Legendary trader Bill Williams, an early pioneer of market psychology, developed the trend-following Alligator indicator, which follows the premise that financial markets and individual securities trend just 15% to 30% of the time while grinding through sideways ranges the other 70% to 85% of the time. Williams believed that individuals and institutions tend to collect most of their profits during strongly
trending periods.

The Three Balance Lines of the Alligator Indicator

The balance lines are designated as the jaw, the teeth, and the lips of the alligator and are as follows:

Alligator’s jaw — this is the slowest moving average of the three, and is marked blue. It is a 13-period moving average, shifted forward by 8 bars.

Alligator’s teeth — coloured red, this is the intermediate moving average of the three, smoothed over 8 periods, and shifted 5 bars forward.

Alligator’s lips — shown as a green line and calculated as a 5-period moving average that is then shifted 3 bars forward.

Trading on the indicator

The Alligator is considered a trend instrument, so it is usually used as an integral part of a trading strategy. But it is quite realistic to trade just using the indicator itself, in particular, if the fractal display function is activated on it.

Alligator signals:

● the intersection of lines – when the green and red curves intersect with each other, this is the main signal to open trades;
● the distance between the lines – the more the curves move away from each other, the more pronounced the trend is;
● the line movement tendency – expansion or contraction, this indicates what stage the Alligator is in (awake or full);
● price deviation – intense price trends are manifested by a significant deviation of the Moving Average beam from candlestick formations.

The image below clearly illustrates the main reversal signal. The arrows indicate entry points to the market with trades on an increase or decrease. A complete reversal would be the intersection of the green and blue lines. However, if the signal is formed when there is a pronounced trend, then it is better to respond to its precursor – the convergence of the red and green Moving Averages.

Alligator

To trade more efficiently, you should consider a few aspects. First, the frequency of signal formation plays a key role. Very frequent reversals (more than 1 every 30-40 candles) indicate a low level of market volatility. Secondly, the deviation of lines from the price is important. A good sign is when during the last period before the market reversal the candles do not touch the red line, and it’s even better if there is no breakdown of the green curve.

For Purchase:

The price punches the key line from below up and is closed above a point of intersection. Lines have to be directed to the north and be built accurately in order

AlligatorsLips < AlligatorsTeeth < AlligatorsJaw (from below up).
While the price moves higher than green line the trend is bull.

For Sale:

The price punches the key line from top to down and is closed below a point of intersection.

Lines have to look to the south and be built in order
AlligatorsJaw < AlligatorsTeeth < AlligatorsLips (from top to down).
While the price moves under the green line the trend is descending.

The range of volatility is defined by distance from green to the blue line, and the tilt angle allows to estimate force of a new trend.

How Does The Alligator Indicator Work?

Since the market evolves from trend to range, we can think of the market much like an Alligator:

● When the market is ranging, the Alligator is sleeping
● When the market shows signs of a trend, the Alligator wakes up

You monitor the condition of the 3 lines to determine what state the “Alligator” is in.

There Is No Trend In The Market
When the 3 lines are intertwined, we do not have a trend. This is generally a time of low volatility and most traders may want to find another instrument to trade.

Possible Trend Forming
The lips of the Alligator, the green line, is the fastest moving average and will be the first one a trader will want to monitor. You want to see the green line cross both of the slower moving averages. This is a sign that the Alligator is waking up. We will also see the lips and the jaw start to turn in the direction of the green line. Many traders will enter the market following a candle close above/below all 3 lines at this point.

Trend Formed And Direction
Considering an up trend, the green line (lips), crosses the red and sometimes the blue line depending on the market state. The red line (teeth) starts to head upwards crossing the blue (jaw) line and we now determine an uptrend is in place.


Here is a great analogy which will help you decide when a trading opportunity could be presenting itself:

When the 3 lines of the Alligator indicator are intertwined, the Alligator is sleeping. When an Alligator is sleeping, nothing interesting is going on. The longer the Alligator sleeps, the hungrier it may be when it awakes.

Think of a market that is ranging – we know it will break out and the longer the range continues, the more violent the breakout can be

As the green line starts to cross (the lips opening), we could be looking at an Alligator getting ready to feed. This is the time that you want to be on alert for a trading opportunity.

As the green line continues in one direction, the red line which represents the teeth of the Alligator, begins to separate and move in the same direction – the teeth are opening.

Once the first 2 lines start to pull away from the blue line, the blue line trends in the same direction – the Alligator has opened it’s jaws and is looking to feast. The trader is looking to feast on the price action that is happening.

● If the lips (green line) cross the teeth (red) and jaws (blue line) to the upside, consider a bullish Alligator and look for long trades
● When the lips cross the teeth and jaws to the downside, consider looking for short trades as we have a bearish Alligator potential

At this point, you have learned how to setup and use the Williams Alligator to determine the state of the market and the trend direction.
There are several trading strategies you can use and keep in mind that all indicator based strategies do lag the market.

Trading With The Alligator Indicator

The indicator alerts us to 3 stages of market development and with understanding those, you can design a simple approach to trading the market:

● The Alligator is sleeping when the 3 lines are intertwined – market is a rest
● The Alligator is waking up when the green line (the lips) crosses the red and blue lines – possible trend forming
● The Alligator is eating when a candle closes above/below all 3 lines – you should be in the market

You must keep in mind that since we are using displaced moving averages, each of the 3 lines will be plotted ahead of price by the factor of the displacement – 3, 5, and 8 periods. This may affect the trading strategies you use.

Trading Ranges And Breakouts

When the Alligator is sleeping, the market is range bound and a range trading strategy may be used which can give you a jump into the market early. You can see in this graphic the 3 lines mixed together. When this occurs, section of the previous high and low and using your entry tactics, trade inside the range.

Also note on the far right, price has broken from the range and pulled back – classic breakout/pullback trade. At the same time, the spacing of the Alligator lines is supporting your short trade.

Trading Pullbacks In Price

Once the lines have shown a direction, you can resort to using a price pattern that is a staple of all traders – pullbacks.

You want to see all lines pointed in the same direction, in order, which shows a trend is underway. Unlike the first strategy, trading pullbacks in a maturing trend does pose risks as the trend may run before giving a trading opportunity.

You can determine the length of pullback needed by choosing where price has to pull back to. Here you can see obvious pullbacks that have pulled to the green and red line while the blue kept the upwards slope.

The horizontal line is not a perfect pullback but the tail on the lower green candlestick is a price action reversal near the first pullback low.

On the far right, you can see this pullback failed however there was not break above the yellow line before price began to close under the 3 lines.

Alligator Line Cross

The simplest trading strategy for the Alligator is to trade the close of a candlestick after it crosses the lines. I would suggest that traders look at support and resistance to ensure the buy and sell signal is not right into a previous cluster of price.

Note the the green line has crossed over the red to the downside. Remember, these lines are displaced into the future and would have plotted in front of the candlestick we are shorting.

● Green line has crossed the red to the downside
● Short at the low of the candlestick that closed below all 3 lines
● Close your position when a candlestick closes above all 3 lines

As for a stop loss when using the Alligator, consider using a multiple of the average true range or use previous swing high and lows.

In Closing

The most important part of the Bill Williams Alligator is when the 3 lines are mixed together. This is when the Alligator is considered to be sleeping and no trading signals are present.

You should keep these instruments on your radar especially if price action is hinting at an increase in momentum. The best time to get on board a trend move is just before it happens.

While you may not be able to pick the exact price the trend begins, getting in as close to the beginning as possible should be your goal.

When the Alligator is feeding, watch for pullbacks against the main trend direction and trade those moves with a pullback strategy.

As with any trading strategy, it is vital that you test it, lay out a trading plan, and ensure risk management is priority one.

Calculation procedure

The Alligator uses a set of moving averages with different parameters of the shift.

The average price, necessary for calculation, is defined as: PriceMedian = (PriceHigh + PriceLow)/2.


The calculation begins with the value of simple moving average, and further, it is calculated by a formula:

(SMMAi) = (SUM(1) – (SMMAi-1) + PriceMedian(i)) / N,

where

SMMA(i) — smoothed value of the current bar (without the price of the
first);

SUM(1) — the sum of PriceMedian within N periods (since the previous
bar);

(SMMAi-1) — smoothed value of the previous bar;

PriceMedian (i) — the average price of the current bar.


Three dynamic lines appear on the price schedule:

● SMMA (MedianPrice; 13; 8) – the smoothed 13-period moving average displaced on 8 bars forward; the author’s name − Alligators Jaw, color by default – blue.
● SMMA (MedianPrice; 8; 5) – the similar moving average displaced on 5 bars forward; AlligatorsTeeth, color – red.
● SMMA (MedianPrice; 5; 3) – the moving average displaced on 3 bars forward; AlligatorsLips, color – green.

Parameters and settings
Let’s look at it in detail:

Alligator is a classical example of trade signals on a break through or a turn from borders of range and power levels.
The following states are possible:

«The Alligator sleeps»

All lines move horizontally, are closely bound among themselves and the price fluctuates in the narrow range around red. There are no trade signals. The longer the flat period, the more «hungry» will wake up the Alligator: the price throw will be stronger and a new trend will be longer.

«The Alligator yawns»

The fastest AlligatorsLips (green) reacts ahead to activity of the market – in the direction of a price impulse. Crossing it by the price is considered the advancing signal, but you shouldn’t open the transaction. Gradually lines are developed in a necessary order, the distance between them increases (the period of «hunting» opens).

«The Alligator opens a mouth»
If the interest of the participants of the market doesn’t weaken, then red
AlligatorsTeeth begins to react after green, and the slow blue AlligatorsJaw
line always develops the last.

«The Alligator falls asleep»
The return intersection of lines (The Alligator loses interest in «food») before a turn or consolidation is considered the moment of the closing of positions.

For a turn, the lines have to be crossed consistently in a strict order: green-red-blue, their relative positioning remains in the period of a
trend. On a turn or transition in flat there is the reverse crossing of lines, but it is obligatory – according to the same scheme.

The result?

The moment of crossing by the price of all three lines will be a strong signal for an entrance to the market; the transaction on kickback from Alligators Teeth looks riskier.

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