Williams Alligator Study
By Samantha Baltodano
TL;DR:
The Williams Alligator Study is a trading strategy developed by Bill Williams that is based on the idea that financial markets and individual stocks trend only 15-30% of the time, while the rest of the time they are range-bound.
The strategy uses three smoothed moving averages, set at five, eight, and 13 periods, which are plotted on a chart. These moving averages are called the teeth, jaws, and lips, and they are used to identify trend changes and trading opportunities.
When the lips cross the jaws and teeth downward, it signals a short-selling opportunity, and when it crosses upward, it signals a buying opportunity. The strategy also uses the concept of the alligator "eating," "sleeping," or "sated" to indicate when to hold or close positions.
What Is Williams Alligator Study?
The Alligator Study was developed by the legendary trader Bill Williams, an early pioneer of market psychology.
It follows the premise that financial markets and individual stocks trend only 15% to 30% of the time while grinding through sideways ranges the other 70% to 85% of the time.
Williams believed that individuals and institutions often collect the majority of their profits during strongly trending periods AKA 15% to 30% of the time.
How the Williams Alligator Indicator Works
When applied, the Alligator indicator has three lines. By default, the three lines are in red, blue, and green.
- The red line is known as the teeth,
- the blue line is the jaws,
- And the green line is known as the lips.
The Alligators mouth opens and closes in reaction to changing trends and trading ranges.
The chart below shows the Williams Alligator applied in a Microsoft chart.
Source: Trading View
Figure 1: Alligator Indicator example on Microsoft stock
But..what exactly do these terms mean?
The Alligator indicator uses three smoothed moving averages, set at five, eight, and 13 periods, which are all Fibonacci numbers.
- The jaw is the 13-period smoothed moving average that is moved into the future by 8 bars.
- The teeth is the 8-day smoothed moving average that is moved five days into the future
- The lips is the 5-period smoothed moving average that is moved by 3 bars into the future.
The smoothed moving average is a type of Moving Average that uses a longer period to compute. When it is calculated, it does not refer to a fixed period but takes all available data into account. You calculate this by subtracting the previous Simple Moving Average from today’s price.
Other types of moving averages are simple, exponential, and weighted.
Calculating the Alligator Indicator
Simple moving average (SMA):
- SUM1 = SUM (CLOSE, N)
- SMMA1 = SUM1/N
- Subsequent values are:
- PREVSUM = SMMA(i-1) *N
- 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.
Interpreting the Alligator
The indicator applies convergence-divergence relationships to build trading signals. The Jaw makes the slowest turns and the Lips make the fastest turns.
The Lips crossing down through the other lines signals a short sale opportunity. Williams refers to the downward cross as the alligator "sleeping".
If the Lips cross upward signals a buying opportunity. Williams refers to 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 referred to as the alligator "eating with its mouth wide open."
Indicator lines converging into narrow bands and shifting toward a horizontal direction denote periods in which the trend may be coming to an 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 are criss-crossing each other repeatedly, due to choppy market conditions. According to Williams, the alligator is "sleeping" at this time. Remain on the sidelines until it wakes up again. This exposes a significant drawback of the indicator because many awakening signals within large ranges will fail, triggering whipsaws.
Let’s break these down in a couple examples.
Examples of the Alligator Indicator
Source: Investopedia
Figure 1: Williams Alligator example 1
Meta, formerly Facebook, (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" phase.
On the rise, the price drops to the Jawline, but the indicators do not cross each other. The trend remains up.
An alligator "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.
Source: Investopedia
Figure 1: Alligator indicator example 2
In the lower-left of the chart, the Alligator opens up, and an uptrend remains 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. As the price pulls back, the Alligator is sated, and then it opens again for a big uptrend.
This is followed by an extended sideways period, in which the indicator lines crisscross back and forth. This is a sleeping phase, and most traders are best to stay away.
At the far right of the chart, the Alligator is opening its mouth again, or awakening, signaling a downtrend.
Final Notes
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 use the alligator indicator together with the MACD indicator. By combining the indicator with the MACD, you reduce the chances of a false breakout.
Summary
- 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.
- It is wrong to use the Alligator indicator when the price of an asset is consolidating AKA a sideways market. Alligator indicator is meant to be used during trends (upwards or downwards).
- The indicator applies convergence-divergence relationships to build trading signals, with the Jaw making the slowest turns and the Lips making the fastest turns.
Williams Alligator is just one of many studies that Archaide automates. For a full list of strategies and studies available click here.
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