Alligator Technical Indicator for Trending Markets

Most of the time the market does not move anywhere. 
Just 1530% of all time the market forms some trends 
and the traders, who are not in the trading room, 
make their profit by the trend movements. 
My grandfather often said: 
Even a blind chicken will find a corn if you feed 
it the same time every day. 
We call the trend trading blind chicken market. 
Although, it took us several years to work out an indicator, 
which allows to keep the gunpowder dry 
until we reach the blind chicken market.

Bill Williams

A moving average-based trading system is successfully used by traders in trending markets (such as currencies, for example), and one of its main instruments is the alligator indicator. The alligator was first described by Bill Williams in his book New Trading Dimensions. Some software packages include the alligator indicator, but if it's not available, all you have to do is take three smoothed moving averages using 13, eight, and five periods and shift them by eight, five, and three bars into the future. The longest period line is blue (the alligator's jaw), the middle one is red (the alligator's teeth), and the shortest one is green (the alligator's lips).

According to Williams, when these three moving averages are twisted together, it means the alligator indicator rests, and so we also rest. But the longer the alligator sleeps, the hungrier it is. So when the alligator awakes after a good, long rest it is very hungry to hunt for food. And its food is price.

Your challenge is to keep company with this animal and hunt with it; otherwise, you yourself risk being eaten. When all three lines are aligned, going up one after another with the green being greater than red being greater than blue, prices are in an uptrend. You need to look into the possibility of buying. In the event they move down, with the green being less than the red being less than blue, then you'll be looking into the possibility of selling since it indicates a downtrend. If moving averages are entwined, then it is best to be out of the market.

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Balance Lines

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.

Basic Rules

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.

Trading System

1. D1 time frame indicates the direction of signals. With the naked eye you can see that prices do not move in a straight line but rather in peaks and troughs. In other words, trends move in waves.
Charles Henry Dow, in his Dow Theory, identified three trend categories: primary, secondary, and minor. The primary tendency is similar to the flow. The secondary resembles waves that constitute flow. The minor trends look like ripples.

The trend is presented in the D1 (daily) time frame as a flow. This means that your aim is to find a wave inside the flow that is moving in a different direction in order to identify a useful entry point. And because of this we use the H4 time frame. At this scale you are waiting for the alligator moving against the day signal.

2. If D1 is in an uptrend, then you need to wait for the downtrend on H4 (four hours). If D1 is in a downtrend, then you must wait for the uptrend on H4. You need to wait for a good entry along the trend. For this reason we use the M30 (30-minute) time frame. Suppose that on the daily chart the alligator looks upward. The next step is to wait for the downward wave on H4. And when the alligator gives a buy signal, after the moving averages cross over and are trending higher, you would enter a long position. The trade system has finished configuration:

- D1 upward, H4 downward, M30 buy
- D1 downward, H4 upward, M30 sellYou can also use this trading system for shorter-term trading. For example:
- H4 upward, H1 downward, M5 (five-minute) buy
- H4 downward, H1 upward, M5 sell

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During the buy or sell signal setup, you are waiting for a precise and reliable moving average crossover. Now you could look at the closing price of the candle. If there is a crossover at closing time, you have a signal. In the event the moving average crossover did not happen, you would have to wait for the next closing price. Once you have opened a position, the best area to place a stop-loss is over the price pivot.

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To define the price target look also at some of the more classic technical analysis. Essentially, you are looking at important resistance and support levels or we wait for a trend reversal or the start of a correction. This means a reversal price pattern or a divergence with price at oscillators. The direction and target of the signals are derived from the lag by the longest of three time frames in this trading system.

Tips & Tricks

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. 

2. Divergent Bar
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. 

3. Reversal Bar
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.

Sources and Additional Information:

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