The Williams Alligator is a real trading technique, not a vicious reptile. Though, as with any financial trading, if you don’t do your homework thoroughly, it could well turn around and bite you.
The alligator term was coined by legendary Wall Street trader Bill Williams, and represents the stylised shape of an alligator’s head on a line graph created by three different sets of prices.
The lines for this alligator indicator are drawn from three types of smoothed simple moving average (SMMA) – more on smoothing in a moment. The time periods they are based on (often known as bars, as in a bar graph) could be anything from 5-minute periods to days.
- The jaws of this imaginary alligator are represented by a 13-period SMMA, moved into the future by eight time periods
- The teeth are represented by an eight-period SMMA, moved forward by five time periods
- The lips are a based on a five-period SMMA, moved into the future by three periods.
Those Fibonacci numbers keep cropping up and all the numbers in this alligator trading strategy – 3, 5, 8, 13 – are Fibonacci numbers, which are also used in other trading systems, not just the alligator indicator trading system.
So, let’s just recap briefly on moving averages. A simple moving average is the average price of a stock over a set number of days. If the price of widgets is increasing by £1 every day over a 10-day period, starting at £1, the average will be the sum of (1:10) ÷ 10, or 5.5.
On day 11, the first day’s figure drops off and day 11’s is added – so the average is moving from day to day, creating a simple moving average (SMA). You can then go on to create an exponential moving average (EMA), which weights the calculation more towards recent prices, to avoid time lag in the graph.
Smoothed moving average
In an SMA you lose historic data at the start of a time period every time you add new data; in a smoothed moving average, old data is never completely removed, but rather included as a weighting.
Don’t worry if this is making your eyes glaze over – thankfully you don’t have to do all the calculations yourself. We haven’t attempted to illustrate the formula as it’s complex. The good news is that most decent trading platforms will do all the calculations for you, allowing you to select your chosen method and overlay the results on any given stock price chart.
So back to alligator trading. In essence, the system uses those three SMMA lines to analyse the likely direction of stock movements. The alligator lips will move the quickest, with the jaw making the slowest changes in direction.
Lips crossing down through other lines signals a chance for a ‘sell’ trade, or a ‘short’, and is known as the alligator ‘sleeping’.
Lips crossing lines in an upward direction suggests a buying opportunity as the alligator is ‘awakening’.
If the three chart lines are moving higher or lower and are fairly wide apart, it indicates longer term trends where you should hold your current position, and is known as the alligator eating with its mouth wide open.
Converging lines moving towards the horizontal suggests a trend may be about to end – the alligator is ‘sated’, according to Williams.
However, if the three lines continually cross over each other, this shows the alligator is ‘sleeping’ and can indicate difficult market conditions. Jumping on a sleeping alligator can have serious implications for your health (or wealth), so so Williams recommends avoiding opening new positions in these situations.