Introduced by Bill Williams in 1995, the Alligator is as much a metaphor as it is an indicator, helping the trader confirm the presence of a trend and its direction, and also designate impulse and corrective wave formations. The indicator consists of three lines that are overlaying on a pricing chart, and they represent the jaw, the teeth and the lips of the beast.
• Alligator Formula
The calculation of these three lines can be explained as follows:
1) The Alligator’s Jaw, the “Blue” line, is a 13-period Smoothed Moving Average, moved into the future by 8 bars;
2) The Alligator’s Teeth, the “Red” line, is an 8-period Smoothed Moving Average, moved by 5 bars into the future;
3) The Alligator’s Lips, the “Green” line, is a 5-period Smoothed Moving Average, moved by 3 bars into the future.
There are some meanings with different line formations. When these three lines are entwined, then the Alligator’s mouth is closed and in a dormant state. As time goes by, he gets hungrier by the minute, waiting for a breakout from his slumber. When the Alligator awakes, the Green line moves first, followed by the Red line, to confirm a breakout in a new direction.
• How to use the Alligator in Forex Trading
The features of the Alligator are including his “eating” habit when lines are apart, and “sleeping” habit when they are entwined. Since trends may only occur 20% to 30% of the time, the indicator helps traders keep muted until a valid trend is presented. Once a new trend occurs, the Alligator helps the trader remain in his position.
Investors or traders should keep a close eye on the key points in three situations, which are when the lines are entwined, when they are apart, and when the red and green lines cross. When entwined, the Alligator is dormant, and patience is what investors need at this moment. When apart, the indicator is eating, and investors should stay in the trade as long as the candlesticks ride above or below the Alligator. When the lines converge or cross, it’s signalling that it may be a right time to enter or exit.
• In Conjunction with Other Indicators
It is fact that as with any technical indicator, an Alligator chart will never be 100% correct in predicting its future trend. However, to make optimal entry and exit points, investors should use 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.
A brief trading system would be:
1) Anticipate your entry point when the Alligator lines are entwined (“sleeping”) and the “CCI” indicator is signalling 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.
The Alligator is an indicator that helps the trader confirm the presence of a trend and its direction, presented by different formations of those three lines. To make more accurate decision on enter and exit points, combining the “CCI” momentum indicator with the Alligator is recommended.
However, please take note that the Alligator is a lagging indicator that works best after a long period of sleep. Although It is not effective in choppy markets, it will tend to keep you riding the wave a little longer than most other trend type measuring gauges, when a strong impulse wave occurs.