Trading with the Alligator indicator
The alligator indicator is one of the widely used trading indicators, which also acts as a trading system in itself. The alligator indicator was developed by Bill Williams in 1995. The name comes due to the fact that the indicator looks like an alligator’s jaws.
Traders call this the Alligator indicator or Williams’ Alligator.
The alligator indicator comprises of three lines which are all based on moving averages. It is an overlay on the price chart and traders name it as the jaws, teeth and the lips of the alligator. Depending on what formation is created by the three lines, traders depict the presence of trend and the direction of the price.
Unlike most other indicators, the alligator indicator works on the basis of the formations which is also widely used in Elliott wave analysis and other forms of wave analysis. This makes it unique because you cannot use a moving average for example to gauge the different waves in a trend.
There are many traits of the alligator indicator. For example, traders have come up with terms such as a sleeping alligator when the three lines are entwined. This is nothing but an intersection of all the three lines in the indicator.
However, as the alligator sleeps, the story goes that he gets hungrier. This phase is depicted by the breakout phase of the indicator. Thus, once the alligator gets hungry, the breakout phase is formed. This is when the three lines start to diverge. The distance between the lines starts to grow broader.
This phase is also seen as a volatility phase.
The volatility phase usually starts at the beginning of a momentum based directional breakout.
Once the breakout occurs and the trend is established, it is seen as a phase where the alligator starts to feast. As the three lines start to converge once again, the alligator is said to be going back to sleep.
After the alligator has his full, he then goes back to sleep, suggested by the three lines of the alligator indicator converging.
While the above scenario might seem a bit childish, it depicts the way the markets work. Typically, trends don’t form instantly and there has to be some background work in place. Thus, the phases when the alligator sleeps and wakes up forms a good metaphor for the markets.
Ever since the alligator indicator was developed, it has been widely used by some traders as it becomes a trading system by itself. Usually, when you use a trading system, it is widely expected that you use other tools for confirmation.
But this is not the case when it comes to the alligator indicator.
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.
Calculating the values of the alligator indicator
The Alligator indicator is simple (and notice this simplicity as mentioned by William’s view of the markets and using technical analysis).
There are just three main lines with the Alligator indicator.
- The Jaws: The Alligator’s jaws is a blue line which is a 13 period smoothed moving average. This is shifted by 8 bars into the future
- The Teeth: The Alligator’s teeth is a red line which is comprised of an 8 period moving average and is shifted by 5 bars into the future
- The Lips: The Alligator’s lips is a green line which is a 5 period smoothed moving average which is shifted by 3 bars into the future.
You will notice that the alligator indicator is nothing but a combination of three different smoothed moving averages each having its own shift into the future periods.
This is one of the fundamental differences with the Alligator indicator compared to other trading indicators. Not many indicators shift the periods into the future which could give some understanding into what price will be doing.
The chart below shows the alligator indicator applied to a price chart.
Alligator Indicator Example
How does an Alligator work?
As mentioned earlier, the Alligator indicator is very simple in the way it is devised. The indicator basically takes an existing indicator (the smoothed moving average) and then uses a combination of different lookback periods and different shifts into the future in order to devise the indicator as a complete system.
Sometimes, traders tend to use an oscillator as well alongside the Alligator indicator in order to filter the signals even better. Some of the commonly used oscillators include the Stochastics oscillator or the CCI index.
The three converging smoothed moving average basically forms when the markets exhibit low volatility.
One of the benefits of trading with the Alligator indicator is that it allows traders to capture trends very comfortably. It also allows you to stay with the trend. One can draw some similarity between the way the Alligator indicator and the Bollinger bands work.
For example, with the Bollinger bands, you know that when the bands contract, they will soon expand, and prices snap out from the narrow trend. With the Alligator, a similar concept is realized when the Alligator sleeps.
As a result, the longer the Alligator sleeps, the higher the chances that a breakout will occur leading to a new trend being established.
The Alligator indicator is used to understand the trending and ranging markets as well. These can be summarized as follows:
- In ranging markets, the Alligator sleeps
- In trending markets, the Alligator wakes up and feeds
To understand these concepts, let’s look at some examples.
The chart below shows the different phases in the market. The rectangle box shows the area when the markets are ranging. You can see how closely the three different lines are entwined. This simply marks the area when the Alligator indicator is sleeping.
Alligator Indicator and Market Phases
This happens as prices tend to move in a range seldom making any breakouts. However, the appearance of this ranging markets suggests that price is preparing for some kind of a trend that will be established.
Right after the Alligator sleeps, you can see that it wakes up. This is seen by the three smoothed moving averages diverging. Notice that the Alligator feeds for the whole time the trend is strong.
After prices reach the top end of the uptrend, you can see that they promptly reversed direction. Here, for a brief period, the Alligator sleeps but wakes up soon enough to feed on the new downtrend that has been forming.
Using the above illustration, we can deduce that the Alligator indicator allows traders to prepare for the upcoming market movements. As and when price action rises to test one of the three moving average lines, you can expect to see the trend being maintained.
Trading trends with the Alligator indicator
The Alligator indicator allows traders to trade both the ranging and the trending markets. However, it is more recommended to trade the trends rather than the ranges because profits can be easily built up in a trending market.
The ranging markets depicted by the sleeping Alligator suggests periods where traders can stay away from the markets and avoid taking undue risk.
One can of course, use other additional indicators in order to further filter the trends. You can also combine the Alligator indicator with price action-based techniques such as trend lines and horizontal support and resistance levels.
The next chart illustrates how to use the Alligator indicator with price action-based techniques.
Using the Alligator indicator with price action
In the above chart, you can see that we have both the horizontal support and resistance levels and trend lines plotted on the chart. You can see for example when the trend line is plotted, price continues to move higher.
This is depicted by the widening smoothed moving averages. As long as the Alligator is awake, the trend is held steady. But once price nears the end of the trend, you can see that the Alligator starts to sleep.
Following this, price breaks the rising trend line and starts to develop into a downtrend.
Another example from the above chart is the support and resistance levels. For example, after the support level was established, you can see the strong trend that pushed prices to the next resistance level.
This move, from the support to the resistance area has been strong and with the Alligator wide awake, you can get extra confidence that the markets are maintaining a strong trend.
Using the Alligator indicator on the MT4 trading platform
The Alligator indicator or Williams’ Alligator is one of the default technical indicators available on most trading and charting platforms. This is available also on the MT4 trading platform which is widely used.
To use the indicator, simply head to the navigation section and from the indicators list, choose Bill Williams and select the Alligator indicator.
Below is an example of the Alligator indicator on your price chart on the MT4 trading platform.
Alligator indicator on MT4 trading platform
You can customize the indicator to a great extent, including the ability to change the colors of the three smoothed moving averages and also be able to change the parameter settings for the indicator.
While you are free to experiment with the settings, do not deviate too far away from the default settings and also the displacement or the shift settings.
The Alligator indicator shows the trends in the markets for the time frame that it is applied to. Therefore, when you change the timeframes, you can find that the Alligator indicator automatically changes depending on the price action of the time frame that you are viewing.
In this way you can make use of multi-time frame analysis in using the Alligator indicator. It can get a bit complex, but this multi-time frame approach can help you understand the intricate details of the trends that are formed. It will also allow you to fine tune your entry price levels for a trade.
When using the Alligator indicator bear in mind not to use redundant indicators. For example, you can avoid using moving averages because this is the basis for the Alligator indicator.
Similarly, other indicators that overlay on the chart are also not required. You could instead look at various oscillators or even the Bollinger bandwidth oscillator which can depict the rising and falling volatility in the price of the security that you will analyze.
Trading with the Alligator Indicator – In conclusion
In conclusion, the Bill Williams’ Alligator indicator is one of the simplest trading indicators that also works as a technical trading system. The main purpose of the Alligator indicator is to keep trading simple.
Unlike regular trading indicators and technical analysis concepts, Alligator indicator is in line with Williams’ view of understanding current price action to predict future price action.
Overall, the indicator is easy to understand as illustrated in the above article. A number of trading strategies can be devised using the Alligator indicator. It is not surprising that the indicator is such a popular trading system among traders.