What is the Alligator Indicator?
The Alligator Indicator, based on Chaos Theory and applied
to financial markets, is one of the technical analysis tools. Developed by well-known
market figure and author Bill Williams, the Alligator Indicator utilizes the
core concepts of Chaos Theory to identify market trends and possible reversal
points. This indicator assists us in determining market trends, pinpointing
entry and exit points, and staying away from trades within a horizontal
channel. Inspired by the behavior of an alligator, Bill Williams named this
indicator “Alligator”. The Alligator Indicator consists of a combination of
three moving averages, calculated by shifting these moving averages over
specific periods. These three balance lines are as follows:
- Alligator’s Lips (Green Line): 5-period simple moving average (SMMA - Smoothed Moving Average).
- Alligator’s Teeth (Red Line): 8-period simple moving average (SMMA - Smoothed Moving Average).
- Alligator’s Jaw (Blue Line): 13-period simple moving average (SMMA - Smoothed Moving Average).
The indicator provides information about the strength and
direction of the trend based on the movement and convergence or divergence of
these three lines. The usage of the Alligator Indicator often relies on the
intersections and divergences of these three lines. If the three lines
converge, the Alligator is either quiet (underwater) or asleep. This indicates
an uncertain market condition and suggests staying away from trades. (See
example visual a.) As the waiting period prolongs, the Alligator will become
hungrier. When the Alligator awakens from a deep slumber, it will swiftly move
towards more distant price levels, resulting in significantly impactful price
movements.
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| Williams Alligator in the EUR/USD chart |
In a period when the Alligator is awake, the market becomes more lively and volatile. During this time, the positions of the Alligator’s jaw, teeth, and lips provide more clues about the strength and likely direction of price movements. When the Alligator awakens, it seeks to hunt, meaning prices will move within a trending direction, either upwards or downwards. If prices are arranged above the Alligator’s mouth, it heralds an upward trend. In this scenario, prices generally continue to rise. (See example visual b.) On the other hand, if prices are below the Alligator’s mouth, it indicates a downward trend. In this case, prices show a tendency to fall, suggesting an overall selling pressure in the market. (See example visual c.)
How to Trade?
When these three lines (blue, red, and green) are moving
upwards and the gap between them is increasing, it indicates that the market is
dominated by bulls and a strong uptrend is forming. Traditionally, if the green
line crosses above the red and blue lines, it signifies a Buy signal.
During this time, the candlesticks begin to align above the Alligator’s mouth
(formed by its lips, teeth, and jaw). Similar to other indicators, the
Alligator Indicator also provides signals with a delay. By the time the Buy
order is placed, the trend has already begun, but it’s considered safer and
less risky. To capture the signal early, some traders employ different
strategies. For example, they wait for the green line to cross the red line and
then for a candlestick to close above the red line before placing a Buy order.
In an uptrend, these three lines play the role of support levels. Candlesticks
often cross the green line (first support level) from above to below, which is
considered a retracement. However, if candlesticks cross the red line (second
support level) from above to below, it indicates a weakening of the uptrend. Accordingly,
we should definitely place a Stop Loss order below the red line.
If these three lines (blue, red, and green) are moving
downwards and the gap between them is increasing, it indicates that bears are
dominating the market and a strong downtrend is forming. In the classic
scenario, if the green line crosses below the red and blue lines, it signifies
a Sell signal. During this time, candlesticks begin to align below the
Alligator’s mouth (formed by its lips, teeth, and jaw). To capture the early
stages of a downtrend, we can place a Sell order by waiting for the green line
to cross below the red line and then for a candlestick to close below the red
line. In a downtrend, these three lines play the role of resistance levels. Candlesticks
often cross the green line (first resistance level) from below to above, which
is considered a retracement. However, if candlesticks cross the red line
(second resistance level), it indicates a weakening of the downtrend.
Therefore, it’s more sensible to place a Stop Loss order above the red
line.
Please note. While the information that the Alligator
Indicator provides us with in our analysis can help us understand market
movements and make more informed trading decisions, if we use it alone, sometimes
we may not get the results we want. This is true not only for the Alligator
Indicator, but for all indicators. We should always combine it with other
methods of analysis and market information.