Bill Williams introduced the Alligator which is a system that uses three displaced moving averages to isolate market trends. Bill Williams is the author of several trading books that touch on the chaos theory.
The Alligator consists of the following:
- 13-period moving average displaced by 8 periods into the future (blue)
- 8-period moving average displaced by 5 periods into the future (red)
- 5-period moving average displaced by 3 periods into the future (green)
In our review, we will use the Alligator to point us in the right direction, before entering the trade with a two-bar reversal. This is my variant of using the Alligator.
Bill Williams uses a host of trading tools including Alligator, Awesome Oscillator, Acceleration/Deceleration, Fractals, and Market Facilitation Index. If you want to use the Alligator with these indicators, refer to his books for more information.
Trading Rules – Alligator System
Long Trade Signal
- Green line above red line
- Red line above blue line
- Bullish two-bar reversal
Short Trade Signal
- Green line below red line
- Red line below blue line
- Bearish two-bar reversal
The Alligator Trade Examples
Winning Trade – Trading The Alligator
- The moving averages were crisscrossing. This means that the Alligator was sleeping and storing energy for an impulse move.
- The moving averages aligned and pointed down. The Alligator has set the stage for a bearish trade. This Alligator signal was also confirmed by the strong move down as the Alligator lines spread out.
- The pullback up to the middle moving average ended with an inside bar. We shorted a tick below the inside bar.
Losing Trade – Trading The Alligator
- Prices filled a previous gap just before the Alligator gave the go-ahead for shorts, with the three moving averages aligned. Since prices filled the gap, we could expect support at the same level.
- With the bearish inside bar reversal, we shorted. However, we got stopped out by an outside bar almost immediately.
- This failed Alligator trade was a precursor to a trading range in which Alligator signals were unreliable.
Review – Trading the Alligator System
The main drive of Bill William’s books is that traditional trading indicators do not work because they ignore the chaotic nature of markets.
However, I could not see how the indicators introduced in his book, including the Alligator system, are chaotic. So the Alligator’s trading edge, if any, does not come from applying chaos theory.
Basically, the Alligator is a multiple displaced moving average system. I find this trading method similar to the moving average fake-out by Mark Fisher which also uses three moving averages. Both systems are good at keeping us out of the market when it is going sideways.
To increase the odds of finding strong break-outs, focus on Alligator setups that have just experienced a long period of rest.
To confirm a valid Alligator break-out, look out for impulsive moves when the moving averages align, just like in the winning trade example. You want to see at least three consecutive bars moving along with the Alligator system before trusting the break-out. Without paying attention to the price action, it is unlikely that this trading strategy is effective.
For those interested in the financial chaos and the fractal nature of prices, The Misbehavior of Markets: A Fractal View of Financial Turbulence by Mandelbrot gives an insightful overview.