What is the alligator indicator and how do you use it in forex trading?
Bill Williams, the trader who developed the alligator indicator, believed that markets only follow a trend 15% to 30% of the time. Let’s explore the alligator indicator and see how it’s used to identify trends in forex trading.
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What is the Williams alligator indicator?
The Williams alligator indicator – also referred to as the Williams indicator or alligator indicator – is a technical analysis tool that you can use to identify the formation of a trend in forex trading. Its main purpose is to seek out trends, and to determine possible entry and exit points of your forex trade.
The indicator was developed by American author Bill Williams, who first wrote about it in 1995.
How does the alligator indicator work?
Like many other trend trading indicators, the alligator indicator works by plotting various moving averages (MAs) on a chart. Three moving averages are used, and each represents a part of the ‘alligator’: a blue line represents the jaw, a red line represents the teeth, and a green line represents the lips. These are default colours and can often be customised on a trading platform.
The way the indicator works can be explained using the following analogy. When the alligator's jaw, teeth, and lips are closed (moving average lines are intertwined), it means it is tired or sleeping. This is when many traders avoid taking a position because the trend is too weak.
The longer the alligator sleeps, the hungrier it becomes – when it wakes up, it’s ready to hunt bears and bulls. The alligator opens its jaws (lines uncross and move upwards or downwards) and eats until it is sated.
So now, the alligator has lost interest in the food and it closes its mouth to rest (lines move closer together). This is when some traders close their positions if they’ve made a profit, as the upward or downward trend may have come to a halt.
Alligator indicator calculation formula
To get the alligator indicator formula, you must first determine the median price of each candlestick, which is calculated as (high price + low price) / 2.
How to trade forex using the alligator indicator
To trade forex using the alligator indicator, start by looking at the three key pieces of information that it presents. You can use these as part of your forex trading strategy:
- Lack of a market trend – when the green, red and blue lines are very close to each other or intertwined
- The formation of a trend – when the red and blue moving averages are heading in the same direction, the green moving average passes through them, and all three end up going in the same direction
- Trend direction – a trend only exists when the three lines move in parallel. If the green line is above the red line and the red line is above the blue line, there is an uptrend. If the order of the lines is reversed, (blue top, red middle, green bottom) the market is in a downtrend. When the lines widen, it confirms the trend
With us, you can trade forex using derivatives such as spread bets or CFDs. Both are leveraged products, which means you can trade on the upward or downward price movements without owning the underlying assets.
You can also open your position using a deposit – called margin – which can lower the cost of entry when trading. However, trading on margin comes with added risk, as you could lose more than your initial deposit. That’s because you’ll still get exposure to the full value of the trade, and both your profit and loss is based on the full value.
If you think the alligator indicator is signalling an uptrend, you can open a ‘buy’ position (go long). This enables you to profit from increasing forex prices. If you think the indicator is suggesting a downtrend, you can open a ‘sell’ position (go short), which enables you to profit from falling FX prices. If either of your predictions are wrong, you’ll make a loss.
Follow these steps to start trading using the Williams alligator index:
- Create or log in to your trading account and go to the platform
- Search for the currency pair you want to trade
- Select ‘buy’ or ‘sell’ in the deal ticket
- Choose your position size and take steps to manage your risk
- Open and monitor your trade
Remember, forex is a volatile market and a currency pair can experience a price movement of several pips in a very short period of time. Always perform thorough technical and fundamental analysis before opening a position.
Example of alligator strategy in forex
Let’s assume you want to trade EUR/USD. Depending on where you think the pair’s price is heading, you may want to take a long (buy) or a short (sell) position. The alligator indicator will aid in identifying long or short signals (trends). However, it should always be paired with other technical indicators and analysis to confirm any signals.
First, make sure your EUR/USD chart is set to display candles (not a line chart) and that you are familiar with engulfing candlesticks. Then, wait for the long signal – identified by all three moving averages sloping upwards, in parallel. If the trend continues and a bullish engulfing candlestick occurs, this could be a signal to buy. It would be a good idea to set a stop within your comfortable parameters of loss – below the low of the engulfing candle.
For a short signal, the same rules apply – but in reverse. Make sure your chart is set to display candles and then wait for the short signal, which is identified by the averages crossing downwards and widening (parallel to each other). If it looks like the trend is set to continue, and a bearish engulfing candlestick occurs, this could be a signal to sell. Remember to set a stop a few pips above the high of the engulfing candle.
How to set up the alligator indicator in MetaTrader 4
To set up the alligator indicator in MetaTrader 4 (MT4), follow these steps:
- Download MT4 or open the platform
- Open the chart you want to apply the indicator to
- Click on ‘Insert’ > ‘Indicators’ > ‘Bill Williams’ > ‘Alligator’
You can also customise the parameters and change the MA colours. To remove the indicator from your chart, right click on it and select ‘delete indicator’ in the pop-up window.
Alligator trading strategy summed up
- The Williams alligator indicator is a technical analysis tool that you can use to identify the formation of a trend in forex trading
- The indicator works by plotting three smoothed moving averages on a chart: the alligator’s jaw (blue), teeth (red) and lips (green)
- When the three moving averages are very close to each other or intertwined – there is a lack of a market trend
- When red and blue are heading in the same direction, green passes through them, and all three end up going in the same direction – a trend is forming
- A trend only exists when the three lines move in parallel
- You can set up the alligator indicator in MT4
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