Understanding the Alligator Indicator

Trading trends can be the most profitable approach traders can strive for when getting involved in crypto markets. To identify a trend some will use price action, trend lines, and other technical analysis concepts. A technical indicator that has gained valuable acceptance due to its capabilities is the Williams Alligator, but what is it exactly? Let's dive into this article to understand this indicator and how to use it.

What Is The Alligator Indicator?

It is a trend-trading technical indicator that uses consequent smoothed moving average lines based on a prior simple moving average (SMA) calculation.

That means that it first takes the calculation made by an SMA and then plots the Alligator lines smoothly. This indicator represents a powerful procedure to identify, follow, and infer the end of a trending market.

There are various ways to use the Alligator indicator, the most popular being those that reflect signals on convergence and divergence patterns according to the jaws and lips turns.

The Concept Behind

The Alligator was created by trader Bill Williams, who was a master of trading market psychology, under the notion that the dynamic between buyers and sellers leads to a trend condition only 15% to 30% of the time during the market cycles and that market participants tend to close most of their profitable positions during the stronger phases of the trends.

How The Williams Alligator Works

This indicator plots three smoothed lines based on moving averages calculations with inputs of 5, 8, and 13 periods. These lines are also based on Fibonacci numbers.

What is calculating?

The Alligator calculates first an average of closing prices for a determined period. Consequently, uses the first result to do an additional calculation process for each smoothed moving average that it will finally plot.

See the following table for a better comprehension.

Knowing The Jaw, Teeth, And Lips Of The Alligator

As mentioned previously, the indicator plots three lines. These lines constitute the following:

• Jaw (a blue line): it primarily takes a value of 13 periods (bars) and is smoothed by 8 periods (bars) consequently.
• Jaw (red line): it takes the previously smoothed 8-bar line (SMMA) and it is smoothed now by 5 bars consequently.
• Jaw (red line): it takes the previously smoothed 8-bar line (SMMA) and it is smoothed now by 3 bars consequently.

These three lines perform according to the direction of the trend and flatten when the market enters in a range.

Why Is It Important?

The Alligator represents a tool of such importance to:

• Detect a trend
• Follow it
• Estimate its strength
• Anticipate the end of the trend
• Find a consequent range

Typically, the market moves in cyclical ways, where sometimes (depending on supply and demand) is trending up, others down, and most of the time, according to Williams, moves back and forth (within ranges).

Remember that Williams stated that 15% to 30% of the time the market is trending, so we can infer that the 70% left is moving sideways or, at least, without a clear direction.

The Gap: An Indication Of Strength

When the market begins a directional movement, to the upside or downside, it is essential to identify not only the direction of the price but also how strongly it is moving.

The jaw, teeth, and lip lines all work on expansion and narrowing pathways. When they are narrowing, there is no gap. When they expand, there is a gap between each other.

How to use the gap as an indication of trend strength?

1. When the price starts going to the upside, the bigger the gap, the more strength there is in the demand side from the buyers.
2. Similarly, as the price starts going to the downside, the bigger the gap, the more strength there is in the supply side from the sellers.

When is the trend weakening?

1. When the price starts going to the upside, the narrower the gap, the less strength there is in the movement.
2. Similarly, as the price starts going to the downside, the narrower the gap, the less strength there is in the movement.

Limitations of the Alligator, Common Pitfalls, And Additional Thoughts For Crypto Markets

The Alligator, like other indicators, carries limitations in their implementation. For example:

• It is a lagging indicator, so maybe it is not the best for the shortest time frames and rapid styles like scalping. Typical time frames to use it include weekly, daily, and hourly charts. In some cases, traders use a max 30-min to 15-min charts.
• Excessive adjustment of the inputs on the Indicator can make it perform unrealistically, leading traders to deficient risk management.
• Not suitable for highly volatile markets.

Some pitfalls include:

• Overconfidence on the indicator.
• Misreading of the different cycles of the market.

Final thoughts:

• Consider the intrinsic volatility of crypto markets and prepare a risk management plan.
• Practice on paper trading different strategies for successful implementation when trading live.

Conclusion

Alligator is, after all, a simple but powerful indicator with an outstanding calculation supported by a conceptual idea behind it: the market trends 15% to 30% of the market cycles. This concept leads us to infer that mostly the market is in a range, which is not the most profitable cycle.

In Altrady, you can trade with the Alligator along with other technical indicators by signing up for a free trial account.