Trend indicators attempt to signpost those key times when a trend may be forming. The Alligator indicator — devised by American trader, technical analyst and author 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 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. Not for him the dryness of ATR or RSI — instead, for example, he gave us the awesomely-named awesome indicator. Bill Williams also had a penchant for animal analogies, which goes some way to explaining the naming of the Alligator indicator.
We'll talk a bit more about Bill Williams later in the article, but our primary focus is going to be discussing the Alligator indicator itself and how to use it to trade Forex in MetaTrader 4.
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 — periods of sideways movement — is like a sleeping alligator. Eventually the alligator wakes 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 differing 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.
The three balance lines of the Alligator Indicator
The balance lines are designated as the jaw, teeth and 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.
I find it a slightly confusing choice of nomenclature, given in real life an alligator's jaw is green, we normally think of lips as red and teeth are white! The convention is as described as above, however. The precise ins-and-outs of working out the moving averages are not hugely important, as MetaTrader 4 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 below:
So we want to click on Bill Williams Alligator. Doing this will give you the dialogue box shown in the image.
The parameters are all set at the standard Alligator indicator trading values as a default. When you click OK, the blue jaws, red teeth and green lips all appear on your chart.
The hourly GBP/USD chart above shows how the Alligator technical indicator looks when applied.
How to use Alligator indicator in Forex trading
We mentioned before that there are three key pieces of information shown by the MT4 Alligator indicator about Forex markets:absence of a trend formation of a trend direction of the trend.
Let's discuss each of these three in turn and see how we can use them in 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, red and blue lines all stick close together. This means the alligator is dormant — the market is not really doing anything and we await a change in state.
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, lips and 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 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, we expect this to move first, followed by the red and then the blue line.
The green line crossing above the slower lines is a buy signal. Crossing below them is 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 the alligator is sated and is the signal to take your profit.
The strength of the indicator is the way it helps you 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 necessarily 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.
The trouble is the timing — because the indicator lags the start of the trend and the fall was steep, we missed nearly all the move. The second vertical dotted orange line marks the sated alligator, when the green line crosses back above. The lips, teeth and 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 in my book. This means that I'm 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, I might look at a trend indicator that uses a different methodology to see if it confirms the signals. This would help us ignore false signals in the sleeping phase of the Alligator indicator and might also improve the timing of the 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.
MT4 comes with a fair selection of indicators, but if you want to give yourself a more comprehensive selection of tools, why not try MetaTrader 4 Supreme Edition? MT4SE is a custom plugin which offers a specially extended version of MetaTrader 4 created by market professionals.
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 by a reliance on predicting the unknowable. He, therefore, tried to craft approaches that did not demand predictability and stressed the necessity of being able to read the market itself rather than accepting other's 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 himself 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, in my opinion, a little on the vague side.
I would recommend rigorously testing 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 doesn't work for you is in a risk-free environment. So why not try out our demo trading account?
We hope this article has given you a solid grounding in the Alligator indicator and we wish you the best of luck in all your trading.