Most of the time, the market remains stationary. In fact, it is estimated that only 15 -30 percent of the time, the market moves with a clear trend either up or down, which are the periods when most traders take their profits. For this reason, the famous Bill Williams sought to develop an indicator that would serve precisely to provide entry signals in the periods when the market is most active, mainly those in which the price moves with a definite trend.
This indicator is composed of three lines which are described below:
- The blue line (Alligator’s jaw): is the Balance Line for the time frame that was used to construct the chart, ie for the current time frame. Is calculated as a smoothed moving average of 13 periods, projected into the future by 8 bars.
- The red line (Alligator’s teeth): The Balance Line for a time frame less than the current (lower than the current time frame). Is calculated as a smoothed moving average of 8 periods, projected into the future by 8 bars.
- The green line (Alligator’s lips): The Balance Line for a time frame less than that of “Alligator’s teeth” (a level below the timeframe of this Line of Balance). Is calculated as a smoothed moving average of 5 periods, projected into the future by 3 bars.
The lips, teeth and jaw of Alligator show the interaction of different time periods. Because the clear trends appear only between 15 and 30 percent of the time, it is essential to follow them when they occur and to refrain from trading when the market moves in ranges in which there is no clear trend.
The use of this indicator can be described by the following metaphor:
Essentially, when the jaw, teeth and lips are closed or intertwined, it means the Alligator is going to sleep or is already asleep. As is asleep, is getting hungrier – the more sleep the Alligator, the hungrier it will be when it wakes up. The first thing upon waking is to open its mouth and yawn. Then the smell of the food reaches the alligator´s nose: “meal” of a market that will go upwards or a market that will go down and the Alligator starts to hunt. Having eaten enough to be full, the Alligator starts to lose interest in food (price) and the Balance Lines start to join again (at this point the trader have to take profits). Here, the Alligator asleep again waiting for the time when it is hungry again.
In this case, when we use the expression “the Alligator opens its mouth”, that means that the three balance lines diverge and therefore the market becomes more active, which presents new opportunities for the trader. On the contrary, when we say that “the Alligator closes its mouth”, what this means is that the three lines are intertwined, which means that the market moves in a price range and presents few opportunities so the trader have to wait until the market shows better conditions to trade.
Calculation of the Alligator
- n = number of time periods.
- Maximum (n) = The highest price reached during the time period n.
- Minimum (n) = The minimum price reached during the time period n.
- SMMA (A, B, C) = A smoothed moving average where A refers to the data that will be smoothed, B refers to the period that will be softened and C represents the change in time.
- Median Price (n) = [Max (n) + Min (n)] / 2
- Alligator´s jaw (Blue Line) = SMMA (Median Price (n), 13, 8)
- Alligator Teeth (Red Line) = SMMA (Median Price (n), 8, 5)
- Alligator Lips (Green Line) = SMMA (Median Price (n), 5, 3)
- To become a user-friendly indicator that allows the investor to trade when the market is in a bullish or bearish trend.
- To develop a reliable way to save money when the market moves in price ranges, namely in sideways markets, which are periods when most technical indicators fail.
- To present a simple and reliable methodology to monitor movements in the market.
Uses of the Alligator indicator
Based on what we exposed above, we can define the following methodology to work with this indicator:
-An uptrend is indicated when prices move above the Alligator’s mouth which as we said is composed by its jaw, teeth and lips (blue, red and green lines respectively). In addition, these lines must be aligned and inclined upward, with the green line above the red line that is above the blue line at the same time. Also, all Balance Lines must be under the price.
-By contrast, a downtrend is indicated when prices move below the mouth of the Alligator. In this case, the lines must be aligned and sloped down with the blue line above the red line which is above the green line. At the same time, all Balance Lines should be above the price.
Other applications of the Alligator
- This indicator also can be used to determine the character of the Elliot Waves:
- If the price is outside the Alligator’s mouth the wave has impulsive character.
- If the price is inside the Alligator’s mouth the wave is corrective.
- Divergent Bar: A strong uptrend has prices that increase very rapidly. Alligator’s lines are slow to update compared to market movements (because these lines are based on smoothed moving averages), especially in strong trends, so under these conditions the Balance Lines will be quite backward compared to current price. These conditions result in a divergence between price momentum and the momentum in the Alligator. In this case the price movement is accelerated while the Alligator movement is slower and sometimes it barely moves. When this happens, the trader should look for a trading bar that indicates at least one trend change in the short term.
- Inversion Bar: It is a bar that indicates a possible change in the market trend and it is defined as a price bar that reaches a new high or low, however it closes within the lower 50% of the range of the day. Once this bar has been properly identified and depending on the direction of the possible change in the price trend, the trader can do the following:
- Sell/Buy above/below the maximum/minimum of the inversion bar.
- Place a stop loss slightly above/below the high/low of the bar itself.