How to Use the Alligator Indicator in Forex Trading
This article will discuss the Alligator Indicator and how to use it to trade Forex in both the MetaTrader 4 (MT4) and MetaTrader 5 (MT5) trading platforms. We will also provide traders with information regarding how to combine the Alligator Indicator with other trading tools, and much more!
Table of Contents
Trend indicators attempt to signpost those key times when a trend may be forming. The Alligator Indicator - devised by US trader Bill Williams - is designed to identify when a trend may be forming and what the direction of that trend is. It can also be used to identify the absence of a trend.
Bill Williams indicators tend to have more colourful names than your average analytical tool. Instead of the dryness of the ATR or the RSI - Bill Williams opted for, for example, the awesomely-named Awesome Oscillator Indicator. Bill Williams also had a penchant for animal analogies, which goes some way in explaining the naming of the Alligator technical indicator.
Alligator Indicator: Why the 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 - i.e. periods of sideways movement - is like a sleeping alligator. Eventually the alligator awakens 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 different 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.
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Alligator Indicator: The Three Balance Lines
The balance lines are designated as the jaw, the teeth and the lips of the alligator and are as follows:
- Alligator's Jaw - this is the slowest moving average of the three, and is marked blue by default. 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
The precise method of calculating the moving averages within the Alligator indicator are not hugely important, as the MetaTrader trading platforms will take care of the calculations for you.
How these lines behave describes the alligator's state and, therefore, the state of the market. Before we look at this in more detail, let's first look at adding the Forex Alligator Indicator to a chart in MetaTrader 5.
How to Use the Alligator Indicator in MetaTrader 5
The Alligator indicator comes by default with both MT4 and MT5 and, although we are looking specifically at how to use the indicator in MT5, the process is exactly the same in both trading platforms.
Conveniently, MetaTrader has its own folder for Bill Williams indicators. The folder is listed in the 'Indicators' folder in the 'Navigator' window on the left-hand side of the screen - as shown below:
Selecting the Alligator indicator from this folder will give you the dialogue box shown in the image above. The parameters are all set at the standard Alligator technical indicator settings by default. When you click 'OK', the blue jaws, the red teeth and the green lips will all appear on your chart.
The hourly GBP/USD chart below shows how the Alligator technical indicator looks when applied:
Alligator Indicator Strategy
We mentioned before that there are three key pieces of information shown by the Alligator technical indicator concerning Forex markets which include: the absence of a trend, the formation of a trend and the direction of the trend. Let's discuss each of these three in turn, and see how we can use them within an Alligator indicator trading system.
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The Absence of a Trend
This is a common state in the Forex market and it is indicated by those times when the three lines of the Forex Alligator indicator are close together or entwined. We can observe this in the highlighted portions of the chart below, where the green, the red and the blue lines all get close and intertwine which each other.
This means that the alligator is dormant; in other words, the market is not really doing anything and we are awaiting a change in state.
The Formation of a Trend
A successful awakening of the alligator is observed when the fast green line crosses through the slower ones, the slower lines also follow that direction and all three lines are spreading apart.
When the teeth, the lips and the jaw of the Forex Alligator indicator 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 can expect it to sustain its hunt for food. These periods of persistent trends are when the Alligator technical 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 line and then, finally, the blue line. The green line crossing above the slower lines represents a buy signal. Crossing below represents a sell signal. If all three move higher and widen, it confirms an uptrend. Alternatively, 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 that the alligator is sated and is the signal to take your profit. The key strength of the indicator is the way that it helps you to stick with a persistent trend. One of the drawbacks can be the difficulty in successfully reading the opening signals in a timely manner.
The sleeping period, when the lines are closed and entwined, will 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 USD/CHF chart shown below, the first vertical red line shows a buy signal; you can see the green line cross above the two other balance lines and then all three diverge, indicating the feeding alligator.
Subsequently, the second red vertical line shows the green moving average of the Alligator indicator crossing back below the other moving averages. This is our signal to sell.
Problems can arise with the timing. If the indicator lags too much at the start of the trend, and the fall or rise is steep, we could potentially miss the entire move. An example of this can be seen with the third vertical red line on the chart above. The price rises quickly and, by the time the green line has crossed above the other two, we have missed most of the move and it is not long before the lines become intertwined again.
Combining the Forex Alligator Indicator With Other Trading Tools
No trading tool is perfect. This means that professional traders are 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, some traders might look at a trend indicator that uses a different methodology to see if it confirms the signals.
This would help us filter out the false signals in the sleeping phase of the Alligator technical indicator, and might also improve the timing of the trading 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.
Both MT4 and MT5 come with a large selection of indicators by default, but if you want to give yourself a more comprehensive selection of tools, why not try the MetaTrader Supreme Edition plugin? The MetaTrader Supreme Edition - compatible with both MT4 and MT5 - is a free custom plugin which offers a specially extended version of the popular trading platform and comes with a variety of additional technical indicators!
Final Thoughts
The Forex Alligator Indicator 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 a little on the vague side. It is recommended to rigorously test the indicator before use, in order to determine whether it actually yields positive results for you.
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