Forex traders use a range of indicators as part of their technical research, which helps them to better understand the market and identify the best times to buy and sell currency pairs. The alligator indicator is one of the most popular tools and is particularly useful for identifying when a trend is occurring and in what direction.
The alligator indicator was created by legendary American author and trader Bill M. Williams in 1995 and gets its interesting name from the three “Balance Lines” on the chart, which are named the jaw, teeth and lips. Traders analyze these lines and how they interact to extrapolate the direction of currencies and determine whether there is a trend or if a trend is absent.
The alligator indicator is calculated within MetaTrader 4 (MT4) and MetaTrader 5 (MT5) trading software using a rather complex sequence involving each of the three, different moving averages, with each having their own color on the chart. The blue jaw line is the slowest, 13-period moving average, the red teeth line is in the middle (8-period) and the green lips is the fastest, 5-period moving average. Each of these lines is smoothed and shifted to a certain degree too.
Traders can create a chart on their trading platform by selecting the alligator indicator option from a drop-down list. Using the pre-built parameters, traders can view an alligator technical indicator for their currency pair of choice, such as GBP/USD. The next step is to read the chart correctly to support decision-making in forex.
How to use the alligator indicator in forex?
A forex alligator strategy will use the indicator to identify breakout movements. Data shows forex markets typically have small fluctuations within tight boundary conditions the vast majority of time, so knowing when a new trend is occurring is crucial for profiting from trades, either by entering or exiting the market at the right time.
Using the alligator indicator, the typical, tight-ranging period is evident when the three colored lines are clustered very closely together, which suggests there is currently an absence of any trend as the market is quite quiet. However, the alligator “wakes up” when the fastest, green line begins to outpace the others with the slower lines also heading in the same direction but spreading apart. This is evidence that a new trend is forming.
The indicator can also be used to find the direction of a trend. The green line crossing above the red and blue line is a signal to buy while in the same scenario but crossing below is a signal to sell. Meanwhile, spreading out and higher is an uptrend and spreading out and lower is a downtrend. Being able to read these signals quickly is a skill that traders should try to learn.
A basic strategy using the alligator would have a trader closely follow the dormant, sleeping phase and then take action by selling a currency when the green line crosses lower and placing a relevant stop-loss order. Traders should use other indicators in addition to the alligator to determine the right exit and entry points to minimize losses and maximize gains.