This is the second article in our Alligator series. If you haven’t already we suggest that you check out the first article about the Alligator Indicator. In that article, we covered the background of the Alligator indicator, how it is calculated, and how it looks on a chart. It consists of three lines, overlaid on a pricing chart, and was created to help the trader confirm the presence of a trend and its direction. The Alligator indicator can also help traders designate impulse and corrective wave formations, but the tool works best when combined with a momentum indicator.
The “traits” of the Alligator are numerous and relate to his eating and sleeping habits. Since trends may only occur 20% to 30% of the time, the indicator helps a trader keep his powder dry until a valid trend is present. Once the trend forms, the Alligator helps the trader remain in his position.
How to read an Alligator Chart
The Alligator indicator, with a period settings of “13, 8, 5” and shift settings of “8, 5, 3”, is presented in combination with the candlesticks on the above “Daily” chart for the “EUR/USD” currency pair. In the example above, the “Blue” line is the Alligator’s jaw, the “Red”, his teeth, and the “Green”, his lips. The “CCI” indicator, or “Aqua” line, has been added to assist in reading the signals generated. One must remember that the Alligator, since it consists of moving average crossovers and is shifted ahead, will lag more than the CCI. The CCI will send the first alert, followed by the Alligator crossover and a closing candle above or below the three moving averages (See annotations).
The key points of reference are when the lines are entwined, when they are “open”, and when the red and green lines cross. When entwined, the Alligator is said to be sleeping. Patience is the message given here. When the lines are apart, the Alligator is eating. Stay in the trade as long as the candlesticks ride above or below the Alligator. When the lines converge or cross, it is time to consider entering or exiting, although a momentum indicator will fix a better exit point. Traders are also attentive to closing Candles. In the above example, an exit signal occurs when a Candle closes above the center Red line or teeth of the Alligator. During the second downward move, the Alligator, for this reason, would have kept you in the trade a little while longer for more profit.
As with any technical indicator, an Alligator chart will never be 100% correct. False signals can occur, but the positive signals are consistent enough to give a forex trader an “edge”. Skill in interpreting and understanding Alligator signals must be developed over time, and complementing the Alligator tool with another indicator or pattern of pricing behavior is always recommended for further confirmation of potential trend changes.
In the next article on the Alligator indicator, we will put all of this information together to illustrate a simple trading system using this Alligator indicator.
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