There are countless of technical indicators being used today to gauge financial markets. From Bollinger bands to moving averages, dozens of these tools have proliferated the side of the internet that covers trading and investing. Another buzzworthy indicator that merits attention is the Alligator indicator. What exactly is it and how can one use it to consistently win in the foreign exchange market?
What is the Alligator Indicator?
The Alligator system is designed to identify trend changes and potential reversals. Designed by Bill Williams, the indicator also goes by the name “Bill Williams Indicator” in some trading platforms. It utilizes the behavior of each of three components that constitute the indicator. The three components are mainly simple moving averages that are set at specific parameters and are thus positioned differently in a price chart.
How it Works
As mentioned earlier, an Alligator indicator is made up of three simple moving averages. The first line is set at a 13-day SMA with a shift setting of 8. The second line is an 8-day SMA with a shift setting of 5. Finally, the third line is set at a 5-day SMA with a shift setting of 3. As you can observe, the parameters drop lower with each succeeding line, which is also manifested visually in the chart it is applied to.
Usage of the Alligator Indicator
It is mainly used for early identification of trends. Thanks to not one but three simple moving averages, it is a suitable and decently reliable trend-chasing indicator. Typically, traders will look out for a crossover between the two smaller SMA lines and then with the bigger SMA line. If the crossover happens in an upward motion, it is considered to be a Long or Buy signal. If the cross happens in a downward direction, the signal is thought to be bearish and the trader will theoretically look to sell.
Benefits of Alligator Trading
For starters, the threshold for a signal to be generated is quite high, meaning you won’t end up with too many low-probability signals that result in a loss. Because it uses three simple moving averages, it’s harder for price volatility to manipulate or fool the system. Another benefit of trading the Alligator indicator is that it eliminates the need for stressing over trade ideas. By having a specific strategy you can follow day-in day-out, the likelihood of success increases substantially and stress is reduced since guesswork is removed from the equation.
Tips When Trading With Alligator Indicator
Although it provides higher probability setups, an Alligator indicator isn’t completely risk-free. It should be used with caution and discipline lest incur heavy financial losses. Combine the technical indicator with a broader encompassing approach, which ideally includes a time frame for trades, clearly defined stop losses and profit targets, and diversification. Another tip is to look at the overall context of the market and use it to weigh in on your current trade ideas. If your Alligator indicator generates a signal to buy, but you find the currency pair to already be overextended, it may be smarter, as an investor, to wait for price to correct downwards first before entering.
Automating Your Alligator Indicator
Thanks to Expert Advisors, it’s now possible to automate your trading and remove the strenuous thought process that comes with it. Many trading platforms, such as those offered by AlfaTrade forex broker, allow for simplified creation and management of EAs, something you should definitely look into when you’ve acquired enough fundamental experience. For now, manual testing of the indicator must be done through both rigorous back- and forward-testing on a demo account, and then on a live account. Playing with the indicator on a demo account frees you from any financial risk while providing the learning experience you need to use the indicator profitably.
The Alligator indicator can improve your profitability over time. However, it takes time to masterfully wield any technical or fundamental tool. Make sure you can dedicate your undivided time and attention in learning and mastering the Alligator indicator on different market cycles or patterns. This will give you the flexibility to sit on the sidelines even when the indicator generates a false signal or execute a trade order even if the indicator hasn’t said so.