How to Trade the Alligator Indicator
This article will discuss the Alligator Indicator and how to use it to trade Forex in MetaTrader 4. This article will also provide traders with information regarding how to combine the Alligator Indicator with other trading tools, and much more!
Trend indicators attempt to signpost those key times when a trend may be forming. The Alligator Indicator — devised by American trader Bill Williams — attempts to do this and a bit more. In fact, the Alligator indicator is designed to also identify the absence of a trend, as well as telling you the times when a trend may be forming. Finally, it also indicates the direction of such a trend.
Bill Williams indicators tend to have more colourful names than your garden-variety analytical tool. Instead of the dryness of the ATR or the RSI — Bill Williams opted for, for example, the awesomely-named Awesome Oscillator Indicator. Bill Williams also had a penchant for animal analogies, which goes some way in explaining the naming of the Alligator indicator.
Why Is it Called the Alligator Analogy?
The alligator analogy is designed to help describe some of the behaviours of the market as it goes from non-trending to trending. The idea is that the absence of a trend in the market — i.e. periods of sideways movement — is like a sleeping alligator. Eventually the alligator wakens and sets off in pursuit of its prey. The longer it has slept, the hungrier the beast — in other words, the more pronounced the trend will be.
Bill Williams was insistent that a successful trader will know the structure of the market. In keeping with this line of thinking, the Alligator indicator consists of three moving averages, each smoothed over different time-frames, which he called 'balance lines'. By looking at the behaviour of the balance lines, we can determine the structure of the market — in other words, whether we are dealing with a sleeping alligator or not.
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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
The precise ins-and-outs of working out the moving averages are not hugely important, as MetaTrader 4 (MT4) will take care of the calculations for you. How these lines behave describes the alligator's state, as we'll see in the following sections. Let's first look at adding the Alligator Indicator to a Forex chart in MT4.
Using the Alligator Indicator in MetaTrader 4
Conveniently, MT4 has its own folder for Bill Williams trader tools. The folder is listed in MT4's 'Navigator' after the folders labelled 'Trend', 'Oscillators' and 'Volumes', as shown in the graph below:
Source: MetaTrader 4 - Editing the parameters of the Alligator Indicator in MT4
So we want to click on the Bill Williams Alligator. Doing this will give you the dialogue box shown in the image above. The parameters are all set at the standard Alligator indicator trading values as a default. When you click 'OK', the blue jaws, the red teeth and the green lips will all appear on your chart. The hourly GBP/USD chart below shows how the Alligator technical indicator looks when applied:
Depicted: MetaTrader 4 -GBPUSD Hourly Chart - Alligator Indicator - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.
How to Use the Alligator Indicator in Forex Trading
We mentioned before that there are three key pieces of information shown by the MT4 Alligator indicator concerning Forex markets which include: the absence of a trend, the formation of a trend, and the direction of the trend. Let's discuss each of these three in turn, and see how we can use them with Alligator indicator trading:
The Absence of a Trend
This is a common state and it's indicated by those times when the three lines of the Forex Alligator indicator are close together or entwined. We can see it in in the middle section of our GBP/USD chart above, where the green, the red, and the blue lines all stick close together. This means that the alligator is dormant — and that the market is not really doing anything, and that we are awaiting a change in state.
The Formation of a Trend
A successful awakening of the alligator is a crossover of the fast green line through the slower lines, plus the slower lines following that direction, and all three lines spreading apart. When the teeth, the lips, and the jaw move wide apart like this, the alligator has stirred from its dormancy and is eating. The longer the alligator has lain dormant, the hungrier it is, and the longer we can expect it to sustain its hunt for food. These periods of persistent trends are when the indicator tends to be more effective.
Direction of the Trend
The direction is indicated by the movement of the balance lines. As the green line is our fastest moving average, and we expect this to move first, followed by the red line, and then the blue line. The green line crossing above the slower lines represents a buy signal. Crossing below represents a sell signal. If all three move higher and widen, it confirms an uptrend. If the balance lines move downward and widen after a sell signal, it confirms a downtrend.
As the trend comes to an end, the balance lines draw closer together. The fast green line crossing back over the slower lines shows that the alligator is sated, and is the signal to take your profit. The key strength of the indicator is the way that it helps you to stick with a persistent trend. One of the drawbacks is the difficulty in successfully reading the opening signals in a timely manner.
The sleeping period, when the lines are closed and entwined, will see many crossovers that look like trading signals. The key is in looking for the confirmatory divergence of the balance lines — and doing so quickly enough to avoid missing out on too much of the start of the trend. In the daily GBP/USD chart shown below, the first vertical dotted orange line shows a sell signal — you can see the green line cross below the two other balance lines, and then all three diverge, indicating the feeding alligator.
Depicted: MetaTrader 4 - GBPUSD Daily Chart - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.
The trouble is the timing — because if the indicator lags at the start of the trend, and the fall was steep, we could all potentially miss the move. The second vertical dotted orange line marks the sated alligator, when the green line crosses back above. The lips, the teeth and the jaw become entwined once again, indicating another period of dormancy. There is another sell signal on the far right of the chart, as the green line once again crosses down and all three lines spread apart. The timing of this one would be more favourable than the previous sell signal.
Combining the Alligator Indicator With Other Trading Tools
No trading tool is perfect. This means that professional traders are always looking for ways to use multiple indicators together to try and shore up the weak spots. When it comes to the Alligator indicator, for example, some traders might look at a trend indicator that uses a different methodology to see if it confirms the signals. This would help us ignore the false signals in the sleeping phase of the Alligator indicator, and might also improve the timing of the trading signals.
Alternatively, you could try using a different tack, such as a Momentum Indicator to look for price/momentum divergence, as a way of confirming the veracity of your trading signal.
Bill Williams — Trader, Analyst and Author
Bill Williams is a well-known trader who took a different tack to many analysts, stressing the unpredictability of the market. Williams contended that most trading systems fail through a reliance on predicting the unknowable. He, therefore, tried to craft approaches that did not demand predictability, and that stressed the necessity of being able to read the market itself, rather than accepting other people's views.
Bill Williams also underscored the importance of not overcomplicating things. He maintained that markets can be very simple and that to succeed, a trader needs only to align themselves with the structure of the market. Rather than trying to look at past behaviour to guide future performance, Williams' approach was to look at current behaviour. His indicators are designed to highlight changes in the aggregate behaviour of traders, which results in new trends.
Summing up the Bill Williams Alligator Indicator
The Bill Williams Alligator trading system certainly offers more colourful imagery than normal indicators, which some people may find appealing. While it helps in terms of being memorable, the trading rules are a little on the vague side. It is recommended to rigorously test the indicator before use, in order to determine whether it actually yields positive results for you. The best way to test out what works and what doesn't work for you is in a risk-free trading environment. So why not try out our demo trading account? Where you can trade with virtual currency with real-time price information and much more, so that you're fully prepared before you use these indicators in the live markets.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of, or recommendation for, any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.
