What Is the Williams Alligator Indicator and How Do You Trade With It?

Reviewed by Gordon ScottFact checked by Yarilet PerezReviewed by Gordon ScottFact checked by Yarilet Perez

Legendary trader Bill Williams, an early pioneer in market psychology, developed the trend-following alligator indicator, which follows the premise that financial markets and individual securities trend just 15% to 30% of the time while grinding through sideways ranges the rest of the time. Williams said that individuals and institutions tend to collect most of their profits during strongly trending periods.

Key Takeaways

• The Williams alligator indicator is a technical analysis tool that uses smoothed moving averages.
• The indicator uses a smoothed average calculated with a simple moving average (SMA) to start.
• It uses three moving averages, set at five, eight, and 13 periods. The three moving averages comprise the jaw, teeth, and lips of the alligator.
• The indicator applies convergence-divergence relationships to build trading signals, with the jaw making the slowest turns and the lips making the fastest turns.

How the Williams Alligator Indicator Works

The Alligator indicator uses three smoothed moving averages, set at five, eight, and 13 periods, which are all Fibonacci numbers. The initial smoothed average is calculated with an SMA, adding smoothed averages that slow down indicator turns.

Calculating the Alligator Indicator

SMA:

1. SUM1 = SUM (CLOSE, N)
2. SMMA1 = SUM1/N
3. Subsequent values are:
4. PREVSUM = SMMA(i-1) × N
5. SMMA(i) = (PREVSUM-SMMA(i-1)+CLOSE(i))/N

Where:

• SUM1 – the sum of closing prices for N periods;
• PREVSUM – smoothed sum of the previous bar;
• SMMA1 – smoothed moving average of the first bar;
• SMMA(i) – smoothed moving average of the current bar (except for the first one);
• CLOSE(i) – current closing price;
• N – the smoothing period.

How the indicator is calculated is important for understanding the inner workings of the indicator. Luckily, the calculation is not required in practice. The alligator indicator can be added to your charts from the indicator list in your charting or trading platform.

The three moving averages comprise the jaw, teeth, and lips of the alligator, opening, and closing in reaction to evolving trends and trading ranges:

1. Jaw (blue line): Starts with the 13-bar SMMA and is smoothed by eight bars on subsequent values.
2. Teeth (red line): Starts with the eight-bar SMMA and is smoothed by five bars on subsequent values.
3. Lips (green line): Starts with the five-bar SMMA and is smoothed by three bars on subsequent values.

Williams invoked barnyard imagery to describe the indicator, saying “even a blind chicken will find its corn if it is always fed at the same time … it took us years but we have produced an indicator that lets us always keep our powder dry until we reach the blind chicken’s market.” 

Trading With The Alligator Indicator

The indicator applies convergence-divergence relationships to build trading signals, with the jaw making the slowest turns and the lips making the fastest turns. The lips crossing down through the other lines signals a short sale opportunity, while crossing upward signals a buying prospect. Williams refers to the downward cross as the alligator “sleeping” and the upward cross as the alligator “awakening.” 

The three lines stretched apart and moving higher or lower denote trending periods in which long or short positions should be maintained and managed. This is called the alligator “eating with mouth wide open.” Indicator lines converging into narrow bands and shifting toward a horizontal direction denote periods in which the trend may end, signaling the need for profit-taking and position realignment. This indicates the alligator is “sated.”

The indicator will flash false positives when the three lines repeatedly crisscross each other due to choppy market conditions. According to Williams, the alligator is “sleeping.” You’re to remain on the sidelines until it wakes up. This exposes a significant drawback of the indicator because many awakening signals within large ranges will fail, triggering whipsaws.

Advantages and Disadvantages of the Williams Alligator Indicator

Like any tool in a trader’s kit, the indicator has advantages and disadvantages. Below is a list of the usefulness and limitations of the Williams alligator indicator:

Advantages

• Trend identification: The indicator can be used to identify trends. The alignment of the moving averages, that is, the jaw, teeth, and lips, suggests either the market is trending or ranging.
• Signal clarity: The simplicity of the signals makes it relatively easy for traders to interpret and act. This can aid in making more confident trading decisions.
• Versatility: The Williams alligator can be applied across various time frames, securities, and markets, making it versatile for different trading strategies, whether day trading, swing trading, or longer-term investing.
• Works with other tools: When combined with other indicators, such as fractals or momentum oscillators, the Williams alligator can provide more robust interpretations.

Disadvantages

• Lagging indicator: Trend-following tools such as the Williams alligator are lagging. This means it relies on past price data and might provide delayed signals, potentially causing traders to enter or exit trades later than what’s best.
• False signals: In sideways markets, the indicator can generate false trends, suggesting a market move where none exists, leading to poor trading decisions.
• Parameter adjustments: The effectiveness of the Williams indicator can vary significantly with different settings for the moving averages. Traders might need to experiment with these variables to optimize the indicator for their needs and market conditions.

Indeed, its effectiveness increases when combined with other analytical tools and when it can be adjusted to suit specific conditions. Moreover, understanding and applying the indicator’s limitations are required for continued trading success.

Example of the Williams Alligator Indicator

Meta Platforms (META) has an alligator “awakening” signal near the bottom left of the chart, then embarks on a strong uptrend that shows an alligator “eating with open mouth.” On the rise, the price drops to the jawline, but the indicators do not cross each other. The trend remains up. The alligator’s “sated” sell signal arrives when the lips cross below the teeth, and jaw lines and lines intertwine as the price moves sideways.

The alligator “sleeps” for some time before a new awakening signal goes off, and the uptrend commences with another “eating with an open mouth” phase. The price continues to rise but in a weak fashion. Then there is a sell-off, and the mouth opens to the downside, signaling a downtrend. The lines cross again, signaling that the alligator is “sated.” Until the mouth opens again, it remains on the sidelines.

The alligator indicator can be used in any market or time frame. Next is an example of the EUR/USD currency pair.

In the lower-left of the chart, the alligator’s mouth opens, and an uptrend stays in place for some time. The lines then cross, and two small downtrends develop. This is followed by a buy signal to the upside, which results in a brief uptrend. The alligator is sated as the price pulls back, opening again for a significant uptrend. This is followed by an extended sideways period, in which the indicator lines crisscross back and forth.

This is a sleeping or sideways phase, and most traders should stay away. At the far right of the chart, the alligator is opening its mouth again or awakening, signaling a downtrend.

Bill Williams’ alligator indicator provides a useful visual tool for trend recognition and trade entry timing, but it has limited usefulness during choppy and trendless periods. Market players can confirm buy or sell signals with a moving average convergence divergence (MACD) or another trend identification indicator.

What Other Indicators Can Be Used With the Williams Alligator?

Some commonly used indicators paired with the Williams Alligator include the relative strength indicator, the MACD, the average directional index, the stochastic oscillator, and pivot points. By integrating these indicators with the Williams Alligator, traders can improve the validation of the signals provided, cut the risk of false entries, and manage trades more effectively based on a comprehensive assessment of market conditions.

When Is the Best Time to Use the Williams Alligator?

The best time depends on how it fits with your overall strategy. Position traders may find the Williams alligator effective on weekly charts. Meanwhile, swing traders may prefer the indicator on 30-minute to four-hour charts, while day traders may use the alligator on one-minute to 15-minute charts.

What Are the Most Common Pitfalls When Using the Alligator Indicator?

Some pitfalls include an overreliance on the indicator, misinterpretation of the different phases of the alligator, adjusting the variables on the Indicator too much making it inflexible as well as poor risk management. Practice and continuous strategy refinement are needed for success when using any trading and investment tools.

The Bottom Line

The Bill Williams Alligator is a technical analysis indicator that uses three smoothed moving averages to help traders identify the presence and direction of market trends. By interpreting the convergence and divergence of these averages, traders can discern trending and non-trending securities and markets.

Effective trading with the Williams Alligator involves some patience as they are lagging indicators, and combining this with other indicators for confirmation should improve your trading accuracy and ability to manage risk.

Read the original article on Investopedia.