How To Use It As A Trading Strategy-Indicator For Forex Trading
The Alligator indicator was invented by Bill Williams and uses 3 lines which are actually moving averages with a spin.
Markets trend and market range and the 3 lines of the Alligator indicator, known as the jaws teeth and lips, is designed to alert traders to the presence of either of those market states. #Indicator For Forex Trading
From those states, a trader can determine if they will use a range trading strategy, a trend trading strategy, or wait for a breakout strategy to be used.
What Is The Williams Alligator Indicator?
Three smoothed moving averages are used however they are displaced moving averages. This simply means that the reading is adjusted X bars into the future which better forecasts the future trend direction.
The Alligator indicator settings are:
- Green moving average = the lips of the Alligator and is set to 5 and displaced into the future by 3 periods (whatever your time frame is)
- Red moving average is the Alligator teeth and is set to 8 periods and is pushed 5 periods into the future
- Blue represents the jaws of the Alligator and is set to 13 periods and displaced 8 periods into the future
There are custom indicators for various charts, including Metatrader, to make it easy to apply these averages to your charts.
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.#Indicator For Forex Trading
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. #Indicator For Forex Trading
Trend Formed And Direction
Considering an uptrend, 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. #Indicator For Forex Trading
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 its 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 set up 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. #Indicator For Forex Trading
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 the 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 upward 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 no break above the yellow line before the price began to close under the 3 lines. #Indicator For Forex Trading
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 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.
- Greenline 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 highs and lows.
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 #Indicator For Forex Trading
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, layout a trading plan, and ensure risk management is priority one.