How To Use Alligator Indicator In Your Trading

The Alligator Indicator, developed by renowned trader Bill Williams, is a powerful tool in the arsenal of technical analysts. This indicator, which uses three smoothed moving averages, helps traders identify the direction and strength of market trends. Much like its namesake, the Alligator Indicator “sleeps” when the market is ranging and “wakes up” to hunt when a trend begins. Understanding how to effectively use this indicator can significantly enhance your trading strategy, allowing you to enter trades at the right time and exit before the trend reverses.

The Alligator indicator was part of the Bill Williams trading system which suggested markets trend only 15-30% of the time. The other times, the market is more in a trading range condition that can be difficult to trade.  Markets trend and market range and the 3 lines of the Alligator indicator, known as the jaws, teeth, and lips, are designed to alert traders to the presence of either of those market states.

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?

It is a technical analysis tool that uses a combination of three smoothed moving averages, each displaced into the future, to help traders identify the start and end of trends in the market. The term “displaced” refers to the fact that each moving average is adjusted X bars into the future, which is believed to improve the indicator’s ability to forecast future trend direction.

Traders using the Alligator Indicator can access the complete indicator on popular trading platforms like TradingView, which offers a range of customizable technical analysis tools for your strategies.

How Does The Alligator Indicator Work?

Since the market evolves from trend to range as Williams has stated, we can think of the market much like an Alligator and how it lives in the wild.

Learning how to read the market trend with the alligator indicator is simple:

The default settings of the 3 lines of the Alligator Indicator are as follows:

1. 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)
2. The red moving average is the Alligator teeth and is set to 8 periods and is pushed 5 periods into the future
3. Blue represents the jaws of the Alligator and is set to 13 periods and displaced 8 periods into the future

Using a Forex example, this is a daily price chart of the GBPUSD leading into December 2021.

Let’s go over what the indicator looks like in all three stages:

There is no trend in the market

When the three lines are tangled up, there isn’t a trend to follow. This usually means there isn’t much happening in the market, and it might be a good idea for traders to look for something else to invest in.

It’s not the most exciting time for trading, as there’s low volatility and not much movement. But that doesn’t mean you should give up altogether – just be aware that you might need to switch up your strategy if you want to make some gains.

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.

Trend formed and direction

Considering an up trend, 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.

What Is A Williams Alligator Trading Signal

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

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 it’s jaws and is looking to feast. The trader is looking to feast on the price action that is happening.

Long signal:  The lips (green line) cross the teeth (red) and jaws (blue line) to the upside

Short signal:  The lips cross the teeth and jaws to the downside

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.

Alligator Indicator Strategies

The indicator alerts us to 3 stages of market development and when understanding those, you can design a simple approach to trading the market:

1. The Alligator is in a sleeping phase when the 3 lines are intertwined – market is a rest – do nothing – range trade only
2. The Alligator is waking up when the green line (the lips) crosses the red and blue lines – possible trend forming – look for breakouts
3. The Alligator is eating when a candle closes above/below all 3 lines – you should be in the market – pullback trading

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. Keep in mind that a market that is transitioning from a consolidation to a trend, can give false signals.

You can see in this graphic the 3 lines mixed. When this occurs, a section of the previous high and low, and using your entry tactics, trade inside the range.

Also, note on the far right, that the price has broken from the range and pulled back – classic breakout/pullback trade. At the same time, the spacing of the Alligator lines supports your short trade.

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. This example shows a strong uptrend is underway.

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.

Alligator Line Cross

The simplest trading strategy and trade signal 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 prices.

Note that 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.

1. The green line has crossed the red to the downside
2. Short at the low of the candlestick that closed below all 3 lines
3. 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.

How to Use the Alligator Indicator in Different Market Conditions

Trending Markets:

• When the Alligator’s lines (jaw, teeth, lips) are diverging, it indicates a strong trend. Enter a trade in the direction of the trend and hold the position as long as the lines remain separated.
• Example: In a bullish trend, enter a long position when the price moves above the lips (green line) and hold until the lines start to converge.

Ranging Markets:

• Avoid using the Alligator Indicator in ranging markets as it can produce false signals. Look for other indicators like Bollinger Bands or the Average True Range (ATR) to identify potential breakout points.
• Example: If the Alligator’s lines are intertwined, indicating a sleeping alligator, wait for a clear breakout before entering a trade.

Combining the Alligator Indicator with Other Indicators

To increase the effectiveness of the Alligator Indicator, it’s beneficial to combine it with other technical analysis tools. This approach can help confirm signals and reduce the likelihood of false positives, providing a more robust trading strategy. Here are some popular indicators that work well in conjunction with the Alligator Indicator:

Relative Strength Index (RSI)

The Relative Strength Index (RSI) is a momentum oscillator that measures the speed and change of price movements. It ranges from 0 to 100 and is typically used to identify overbought or oversold conditions in a market.

• How to Combine: Use the Alligator Indicator to identify the trend direction. Then, use the RSI to confirm the strength of that trend. For instance, if the Alligator indicates a bullish trend and the RSI is above 70, it might signal an overbought condition, suggesting it could be a good time to take profits or tighten stop-loss orders.
• Example: If the Alligator’s lines are diverging upwards (indicating a bullish trend) and the RSI is also rising but not yet overbought, it could be a strong buy signal. Conversely, if the RSI is above 70, it might be wise to wait for a pullback before entering a long position.

Moving Average Convergence Divergence (MACD)

The Moving Average Convergence Divergence (MACD) is a trend-following momentum indicator that shows the relationship between two moving averages of a security’s price. It consists of the MACD line, the signal line, and the histogram.

• How to Combine: Use the Alligator Indicator to identify the trend direction and the MACD to confirm momentum shifts. When both indicators align, it can provide a stronger signal.
• Example: If the Alligator’s lines are diverging upwards and the MACD line crosses above the signal line, it confirms bullish momentum, providing a strong buy signal. Conversely, if the MACD line crosses below the signal line while the Alligator’s lines are converging, it could indicate a bearish reversal.

Fibonacci Retracement

Fibonacci Retracement levels are horizontal lines that indicate where support and resistance are likely to occur. They are based on the Fibonacci sequence and are used to identify potential reversal levels.

• How to Combine: Use the Alligator Indicator to identify the overall trend direction. Then, use Fibonacci Retracement levels to find potential entry and exit points within that trend.
• Example: In an uptrend identified by the Alligator Indicator, use Fibonacci Retracement levels to find potential pullback levels (e.g., 38.2%, 50%, 61.8%) where you can enter a long position. If the price retraces to one of these levels and then resumes the uptrend, it confirms the continuation of the trend.

By combining the Alligator Indicator with these additional tools, you can create a more comprehensive trading strategy that leverages the strengths of each indicator. This multi-faceted approach can help you make more informed trading decisions and improve your overall trading performance.

Frequently Asked Questions

What is the Alligator Indicator?

The Alligator Indicator is a technical analysis tool developed by Bill Williams. It consists of three smoothed moving averages, known as the jaw, teeth, and lips, which help traders identify the direction and strength of a market trend. When the lines converge, it indicates a lack of trend (the alligator is “sleeping”), and when they diverge, it signals the start of a trend (the alligator is “waking up” and “hunting”).

How Does the Alligator Indicator Work?

The Alligator Indicator works by using three smoothed moving averages:

• Jaw (Blue Line): 13-period smoothed moving average, shifted 8 periods into the future.
• Teeth (Red Line): 8-period smoothed moving average, shifted 5 periods into the future.
• Lips (Green Line): 5-period smoothed moving average, shifted 3 periods into the future. When these lines spread apart, it indicates a trending market. When they converge, it suggests a ranging market. Traders use these signals to enter trades in the direction of the trend and exit when the lines start to converge again.

How Do You Use the Alligator Indicator in Trading?

To use the Alligator Indicator in trading:

1. Identify Market Conditions: Determine if the market is trending or ranging. The Alligator Indicator is most effective in trending markets.
2. Enter Trades: Enter a trade when the lines start to diverge, indicating the beginning of a trend. For a buy signal, the price should move above the lips (green line). For a sell signal, the price should move below the lips.
3. Exit Trades: Exit the trade when the lines start to converge, indicating the end of the trend.
4. Combine with Other Indicators: Use additional indicators like RSI, MACD, or Fibonacci Retracement to confirm signals and reduce false positives.

What Are the Advantages and Limitations of the Alligator Indicator?

Advantages:

• Easy to Use: The indicator is simple to understand and apply.
• Built-in to Platforms: Available on popular trading platforms like MetaTrader.
• Effective in Trends: Works well in trending markets to identify entry and exit points.

Limitations:

• Less Effective in Ranging Markets: Can produce false signals in sideways markets.
• Lagging Indicator: As a moving average-based tool, it may lag behind price movements, potentially missing early trend reversals.

How Can You Combine the Alligator Indicator with Other Tools?

Combining the Alligator Indicator with other technical analysis tools can enhance its effectiveness:

• RSI (Relative Strength Index): Use RSI to confirm overbought or oversold conditions. For example, if the Alligator indicates a bullish trend and RSI is above 70, it might be a good time to take profits.
• MACD (Moving Average Convergence Divergence): Use MACD to confirm momentum shifts. Enter a trade when both the Alligator and MACD align in the same direction.
• Fibonacci Retracement: Use Fibonacci levels to identify potential support and resistance areas, complementing the trend signals from the Alligator Indicator.

Summary

The most important part of the Bill Williams Alligator is when the 3 lines are mixed. 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.  This is one of the better trend indicators out there if you are looking for both range trading and trend setups.

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.

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, lay out a trading plan, and ensure risk management is the priority. Trading the financial markets is not as easy as many make it out to be.