Bill Williams describes the Alligator as being like a compass which keeps your trading in the right direction. The Alligator helps you spot a real trend and stay out of range-bound trading, which always result in losses. The Alligator is the combination of three balance lines:
Alligator’s Jaw (the blue line) – 13-period moving average at the mid price (High+Low)/2, which is offset 8 bars into the future;
Alligator’s Teeth (the red line) – 8-period moving average at the mid price (High+Low)/2, which is offset 5 bars into the future;
Alligator’s Lips (the green line) – 5-period moving average at the mid price (High+Low)/2, which is offset 2 bars into the future.
What the Alligator does?
The Alligator identifies trending & non-trending markets. It also specifies the direction of the trend.
If all three lines are intertwined, the Alligator is asleep and the market is range-bound. The longer it sleeps, the hungrier it gets. When it wakes up from a long sleep it chases the price much farther, therefore price movements are much stronger.
When the Alligator is asleep, stay away.
If the Alligator is not asleep, the market is either uptrending or downtrending:
- if the price is above the Alligator’s mouth then it’s an uptrend;
- if the price is below the Alligator’s mouth then it’s a downtrend.
Once the Alligator wakes up, it opens its mouth (the three lines diverge) and starts hunting. Having eaten enough, it goes to sleep again (the three Lines converge), so it’s time to take profits.
1. The Alligator also helps to determine the character of the Elliot waves:
- if the price is outside the Alligator’s mouth the wave is impulsive;
- if the price is inside the Alligator’s mouth the wave is corrective.
A sharp up trend will often see prices moving up steeply. The Alligator lines are slow to catch up, and they will be far below prices. Such conditions result in divergence between the momentum in Prices and momentum in the Alligator. Price rise is steep while the Alligator movement is less steep or sometimes flat. When this happens, look for a reversal bar to signal at least a short term reversal.
A reversal bar is a price bar which makes a new high but closes in the lower 50% of the day’s range. Once a reversal bar is identified,
- Sell below the low of the reversal bar
- Stop loss little above the high of the same bar.