Alligator indicator is a multi purpose technical instrument based on three smoothed moving averages with an additional displacement. The indicator is used in the follow-by-trend, range bound and breakthrough trading strategies depending on the market conditions. Bill Williams - a technical analyst and trader who invented Fractal Indicator and %R oscillator - developed the Alligator Indicator by adjusting and smoothing moving averages with different periods. Alligator jaws, teeth and lips point to several layers of price action, show possible retracement depth and indicate market conditions when a breakout happens. The indicator provides reversal signals as well as reflects strong trends.
Most of the forex traders should have noticed that moving averages are lagging. Although this is a powerful indicator to measure the trend momentum and point to the current direction of the price change, delays related to the simple mathematical formula cause a gap between price charts and a moving average, especially in trending markets. Bill Williams resolved the problem of the lag by smoothing values of moving averages and plotting them to several periods behind and in front of the current price. In other words, the displacement of the moving average value into the future helped the indicator to lower the lag and increase the efficiency of trading signals.
What is the Alligator indicator?
Alligator Indicator is a trading tool placed on the price chart, which consists of three lines:
- The Alligator lips. The length or period of this curve is typically set to 5 periods (days or hours, whatever your timeframe is) and displaced into the future by 3 bars. The colour of the line is green;
- The Alligator teeth are represented by the red line, which is a smoothed moving average a length of 8 periods and displacement 5;
- The Alligator jaws are usually shown by the blue line, the period is set to 13 bars, while the value is pushed for 8 bars.
The Williams Alligator Indicator looks like this:
It might seem that the indicator looks in the same way as the triple moving average with exponential extension. However, that not true as a mathematical formula, the lag distance and the speed of reaction is entirely different. Those Forex traders who got used to trading with moving averages will be surprised by the efficiency of a trading system based on Williams Alligator. Continue reading to know more about how to build a profitable trading strategy using the standalone Alligator Indicator.
How the Alligator Indicator works
Bill Williams Alligator Indicator has three signals or stages:
- The Alligator is sleeping - lines are intertwined;
- The Alligator is waking up- lines cross each other;
- The Alligator eats- lines are placed in the correct order by periods.
Despite the analogy with an animal, the technical background has clear explanations. First, when markets are in a sideways range, lows and highs change each other on the price chart. A clear trend cannot be determined as there is no exact sequence of the action. Reversals are often, and accordingly, moving averages with different periods reflect those reversals by crossing each other. The main idea of the sleeping stage is to trade in both directions - sell highs and buy lows. The main advantage of the Alligator indicator in ranging market conditions is that the lines are more sensitive compared to traditional moving averages.
The second stage when the Alligator is waking up is similar to a preliminary signal from such a trend indicator as Ichimoku Cloud, for example. This is an initial condition to start monitoring the price change closer in the scope of possible breakouts and the beginning of a new trend. The main advantage of the Alligator system is that all of the lines are plotted into the future, and their values reflect possible resistance or support in the near future. A breakout of the price range and the moment when the Alligator is waking up is considered as a potentially strong entry signal.
The Alligator eats when all three lines are placed in accordance with their periods. The lips line is the closest to the price, teeth are placed in the middle and the jaws have the largest distance from the recent price on the chart. What does the alligator eat? Right, other animals or prey. In the case with trading in the financial markets, asset quotes are the prey, while other animals eaten by the Alligator are traders trying to withstand the trend. When Alligator lines are placed in the right sequence, strong trends occur.
Alligator Indicator settings
Best Williams alligator settings are the default periods as Bill Williams developed the trading system based on an optimal ratio of the reflection time and the lag. However, a long-term analysis on a weekly or daily chart, for example, suggests enlarging the periods of the indicator lines. Of course, the sensitivity will drop in this case, but the tool will be able to show a deeper level of retracements as its lines also act as resistance and support levels. On the other hand, short-term trading might require lowering the indicator periods to increase the number of entries to the market. But the default settings are already comparatively squeezed, so scalping traders should be careful with using ultra-short periods. Once more recommendation for selecting best settings is to use numbers from the Fibonacci row as they proved their efficiency compared to round-figure periods. The rest of the requirements are common as traders should not forget about the money management and risk management rules, while settings of indicators have to reflect individual trading strategy.
Comparing with Moving Averages
Bill Williams Alligator is an all-in-one indicator capable of providing trading signals alone. In contrast to simple and exponential moving averages with the standard formula, Alligator lines are much more sensitive and they are typically placed much closer to current prices than moving averages with medium- and long-term periods. Let compare the Alligator indicator with a set of simple moving averages.
Alligator versus mid-term MAs
The daily chart below shows the GBP/USD currency pair reversing the downtrend and starring a strong upside movement. There are two MAs added to the chart - the green line is an Exponential Moving Average with the 89-days period, while the blue curve is a simple MA with the same period. As the screenshot shows, the buy-signal from Alligator appeared much faster compared to the bullish crossover of the two Moving averages. The preliminary trading signal came in when the Alligator woke u and the confirmation was delivered when the Alligator started eating. Both signals occurred 5 and 2 days before the two MAs crossed each other, so traders could enter the market with long positions with much more attractive prices.
Alligator & short-term MAs
The daily chart of USD/JPY below confirmed the previous suggestion that the Alligator indicator provides efficient signals much faster than a combination of moving averages even with lower periods than in the previous example. Again, the bullish crossover of the two MAs (simple with the 21-days period and exponential with the 34-days length) occurred much later than the Alligator woke up and started eating, pointing to the beginning of a strong uptrend of the currency pair.
Examples of profitable trading
After traders noted that the Bill Williams Alligator system works faster than a combination of moving averages with different periods, it is time to check out how the indicator will interact with other types of technical indicators. Let is have a look at how Forex traders can build an effective trading strategy based on Alligator indicator with other tools of technical analysis.
Alligator with MACD and RSI
Actually, we take here the well-known trading strategy for liquid currency pairs and replace the moving average with the Alligator in it. As we already mentioned, the lips, teeth and jaws of the Alligator also point to resistance and support levels for the market conditions. If the current daily price breaks through one of them, the further movement is likely. However, several exceptions are possible. The EUR/USD daily chart below shows three bright examples in different stages of the trend.
The first example appeared when the Alligator indicator was eating. EUR/USD bounced off a local top and breached the lips line, which should have acted as a support, limiting the bearish whipsaws. But the day closed below it, pointing to a potentially deeper bearish correction. Nonetheless, the sell-signal was not confirmed by MACD as the histogram and both lines remained in the positive territory, nor by the Relative Strength Index, the value of which stayed above the middle threshold diving the bearish and bullish momentum. Therefore, the breakout sell-signal was ignored.
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The second example is also interesting as it shows that the bullish retracement was limited by Alligators’ blue line. In other words, EUR/USD showed a counter-trend performance against all of the technicals. Traders should have ignored the price action, consider it as a technical correction and short the pair as MACD and RSI confirmed the bearish conditions, although they did not deliver any signal. Thus, the Williams Alligator helped to improve the trading system based on other technical indicators thanks to the sensitive reaction to the price change.
Alligator indicator with ADX
Another example of effective combinations with the Alligator indicator uses the Average Directional Index and BullBearTrend indicator. The NZD/USD daily chart below shows how both secondary technical instruments can provide an additional level of confirmation and increase the efficiency of the trading system based on Williams Alligator. The initial sell-signal occurred when the currency pair ended the bullish retracement and the daily close rate breached the teeth line, while the Alligator started eating. ADX confirmed the change of the traders’ sentiment, the main line began edging higher and finally crossed the threshold, pointing to a strong bearish momentum. The BullBearTrend indicator reflected the bearish reversal.
The profit was taken only on the opposite signal, which was confirmed by the two secondary indicators:
Regardless of the time frame and asset, Williams Alligator Indicator is a powerful reliable and fast technical instrument to show the trends’ direction, reflect different market conditions and deliver profitable trading signals. Thanks to its modified mathematical formula and displacement for the future periods, the indicator calculates possible retracement depth, shows potential resistance and support levels. A trading system based on Williams alligator provides much faster reacting on changing the environment in the market and can be used together with other technical indicators to improve the efficiency and maximize possible profits from Forex trading.