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.
Alligator Formula
The Alligator indicator is common on Metatrader4 trading software, and the calculation formula sequence involves these straightforward steps:
- The Alligator’s Jaw, the “Blue” line, is a 13-period Smoothed Moving Average, moved into the future by 8 bars;
- The Alligator’s Teeth, the “Red” line, is an 8-period Smoothed Moving Average, moved by 5 bars into the future;
- The Alligator’s Lips, the “Green” line, is a 5-period Smoothed Moving Average, moved by 3 bars into the future.
The Alligator indicator is composed of three smoothed moving averages. Traders will occasionally add an “Oscillator” like the “CCI”, as above in Aqua, to enhance the value of the trading signals. In the example above, the “Jaw”, “Teeth”, and “Lips” are entwined while the Alligator sleeps during the initial part of the price action depicted. When the Alligator awakes, the Green line moves first, followed by the Red line, to confirm a breakout in a new direction. In this example, the CCI sent an overbought alert first. The Alligator lagged, but confirmed the signal after a Candle closed beneath the three-line set. The weakness in the indicator is that timing may “lag” due to its future positioning, the reason for attaching a momentum indicator to anticipate the Alligator’s signal.
The Alligator indicator helps the trader stay in the position for a longer period and works best the longer the period of sleep. In the above example, you would stay in the trade until a Candle closed above the middle Red line. Williams also developed a “Gator” histogram indicator to help visually with interpretation, and many other traders have added their own “twist” to enhance the reliability of this indicator.
The “traits” of the Alligator are numerous and relate to his eating and sleeping habits. Since trends may only occur 20% to 30% of the time, the indicator helps a trader keep his powder dry until a valid trend is present. Once the trend forms, the Alligator helps the trader remain in his position.
How to read an Alligator Chart
The Alligator indicator, with a period settings of “13, 8, 5” and shift settings of “8, 5, 3”, is presented in combination with the candlesticks on the above “Daily” chart for the “EUR/USD” currency pair. In the example above, the “Blue” line is the Alligator’s jaw, the “Red”, his teeth, and the “Green”, his lips. The “CCI” indicator, or “Aqua” line, has been added to assist in reading the signals generated. One must remember that the Alligator, since it consists of moving average crossovers and is shifted ahead, will lag more than the CCI. The CCI will send the first alert, followed by the Alligator crossover and a closing candle above or below the three moving averages (See annotations).
The key points of reference are when the lines are entwined, when they are “open”, and when the red and green lines cross. When entwined, the Alligator is said to be sleeping. Patience is the message given here. When the lines are apart, the Alligator is eating. Stay in the trade as long as the candlesticks ride above or below the Alligator. When the lines converge or cross, it is time to consider entering or exiting, although a momentum indicator will fix a better exit point. Traders are also attentive to closing Candles. In the above example, an exit signal occurs when a Candle closes above the centre Red line or teeth of the Alligator. During the second downward move, the Alligator, for this reason, would have kept you in the trade a little while longer for more profit.
As with any technical indicator, an Alligator chart will never be 100% correct. False signals can occur, but the positive signals are consistent enough to give a forex trader an “edge”. Skill in interpreting and understanding Alligator signals must be developed over time, and complementing the Alligator tool with another indicator or pattern of pricing behaviour is always recommended for further confirmation of potential trend changes.
The following trading system is for educational purposes only. Technical analysis takes previous pricing behavior and attempts to forecast future prices, but, as we have all heard before, past results are no guarantee of future performance. With that disclaimer in mind, the optimal entry and exit points that can be discerned from using Alligator analysis in combination with the “CCI” momentum indicator, which has been added in Aqua, and significant Candle closing prices that are positioned at key points related to the three-line set. Over time, you may also develop helpful hints to enhance alerts.
A simple trading system for the above example would then be:
1) Anticipate your entry point when the Alligator lines are entwined (“sleeping”) and the “CCI” indicator is signaling an overbought condition;
2) Execute a “Sell” order after the Green line crosses the other lines and a Candle closes below the three-line set, making sure that your position size is no more than 2% to 3% of your account;
3) Place a stop-loss order at 20 “pips” above your entry point;
4) Determine your exit point after the “CCI” warns of an oversold condition and a candlestick closes above the Red middle line.
Steps “2” and “3” represent prudent risk and money management principles that should be employed. This simple trading system would have yielded two profitable trades of 115 and more than 600 “pips”, but do remember that the past is no guarantee for the future. Also take note that the Alligator is a lagging indicator that works best after a long period of sleep. It is not effective in choppy markets, but, when a strong impulse wave occurs, it will tend to keep you riding the wave a little longer than most other trend type measuring gauges. At the end of the trading day, consistency is your primary objective, and, hopefully over time, Alligator Technical Analysis will help you gain an “edge”.