This is the third article in our Alligator series. If you haven’t already, we suggest that you check out the first article about the Alligator Indicator. In the previous two articles, we have covered the background, the calculations involved, and how to use and read the Alligator indicator. 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.
Forex traders focus on the Alligator key points of reference, which are when the lines are entwined, when they are “open”, when the red and green lines cross, and the positions of various closing Candles. As with any technical indicator, an Alligator chart will never be 100% correct in the signals that it presents, but the signals are consistent enough to give a forex trader an “edge”. Skill in interpreting and understanding Alligator indicator signals must be developed over time. In the example below, let’s develop a simple trading system based on Alligator signals and alerts.
The following trading system is for educational purposes only. Technical analysis takes previous pricing behavior and attempts to forecast future prices, but, as we have all heard before, past results are no guarantee of future performance. With that disclaimer in mind, the optimal entry and exit points that can be discerned from using Alligator analysis in combination with the “CCI” momentum indicator, which has been added in Aqua, and significant Candle closing prices that are positioned at key points related to the three-line set. Over time, you may also develop helpful hints to enhance alerts.
A simple trading system for the above example would then be:
- Anticipate your entry point when the Alligator lines are entwined (“sleeping”) and the “CCI” indicator is signaling an overbought condition;
- Execute a “Sell” order after the Green line crosses the other lines and a Candle closes below the three-line set, making sure that your position size is no more than 2% to 3% of your account;
- Place a stop-loss order at 20 “pips” above your entry point;
- Determine your exit point after the “CCI” warns of an oversold condition and a candlestick closes above the Red middle line.
Steps “2” and “3” represent prudent risk and money management principles that should be employed. This simple trading system would have yielded two profitable trades of 115 and more than 600 “pips”, but do remember that the past is no guarantee for the future. Also take note that the Alligator is a lagging indicator that works best after a long period of sleep. It is not effective in choppy markets, but, when a strong impulse wave occurs, it will tend to keep you riding the wave a little longer than most other trend type measuring gauges. At the end of the trading day, consistency is your primary objective, and, hopefully over time, Alligator Technical Analysis will help you gain an “edge”.