How to Use the Alligator Indicator for Binary Options


This guide will explore the Williams Alligator Indicator — what it is, how it is calculated, and how to utilize it in binary options trading. Additionally, we will examine its pros and cons, compare it with notable indicators such as the MACD, Bollinger Bands, and RSI, discuss different alligator strategies, and ultimately assess whether it is a valuable indicator.

Key Facts About the Alligator Indicator for Binary Options

  • Origin: Bill Williams, a renowned American trader and author who pioneered market psychology in trading, developed the indicator.
  • Concept: The alligator’s body is made up of three smoothed moving averages set at Fibonacci numbers—13 (Jaw), 8 (Teeth), and 5 (Lips)—which shift to portray market trends and phases.
  • Purpose: To help pinpoint whether the market is in a trending or consolidating phase and to signal the possible start of a new trend and end of an existing trend.
  • Confirmation: An uptrend is confirmed when the Lips (green line) are above the Teeth (red line) and the Teeth are above the Jaw (blue line). The opposite signals a downtrend.
  • Unique Feature: It explicitly signals when the market is ‘awake’ (trending) or ‘sleeping’ (consolidating). A sleeping alligator is when the lines are all tangled.

What Is the Alligator Indicator?

The alligator Indicator is a technical analysis tool primarily used in forex, stocks, and commodities trading to pinpoint distinct price trends and their direction in the markets. The indicator consists of three moving averages, which Bill Williams metaphorically named after the body parts of an alligator:

The Jaw (Blue Line) – This is a 13-period Smoothed Moving Average (SMA), moved into the future by 8 bars. It represents the longer-term trend.

The Teeth (Red Line) – This is an 8-period Smoothed Moving Average, moved into the future by 5 bars. It depicts the medium-term trend.

The Lips (Green Line) – This is a 5-period Smoothed Moving Average, moved into the future by 3 bars. It demonstrates the short-term trend.

When these lines are intertwined, the alligator is displayed as ‘sleeping.’ Hence, the market is considered without a clear trend (or in a consolidation phase). Conversely, when the lines begin to separate, the alligator is said to be “awakened,” an evident trend forms, indicating that it might be a good time to take a position where the trend is headed.

The following positions constitute either an uptrend or a downtrend:

Alligator indicator uptrend

Uptrend = The lips above the teeth and the teeth above the jaw.

Downtrend = The lips are below the teeth and the teeth below the jaw.

Calculation of the Alligator Indicator

Here’s the formula for the alligator indicator:

Legend:

N = the number smoothing period.

CLOSE(i) = present closing price

SUM1 = the total sum of closing prices for N periods

SMMA1 = the smoothed moving average of the first bar

SMMA(i) = the smoothed moving average of the present bar (excluding the first value)

PREVSUM = the smoothed sum of the previous bar

How to Trade Binary Options Using Alligator Indicator

The following are the three easy steps to start using the alligator indicator in binary options trading:

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Steps 1 and 2: Choose a Trading Platform and add the Alligator Indicator

First, you need to pick a broker that supports the alligator indicator. Here are two brokers we recommend, along with their background information and instructions on how to access their respective alligator indicator tools:

Pocket Option

Known for its easy-to-learn and user-friendly interface on its website and mobile applications, Pocket Option offers a wide range of assets and markets for trading. 

Quotex

Well known for its more advanced offerings, including a wide range of analytical trading tools ideal for more experienced and advanced Forex binary options trading traders.

Step 3: Make Your Analysis

Lastly, a thorough alligator indicator analysis will determine specific trading opportunities in different markets and assets. Note that there are numerous ways to analyze the binary options-supported asset you have chosen. The following are three relevant alligator indicator-based strategies you can use.

Here Are Three Relevant Alligator-Based Strategies You Can Use:

1. Trend Confirmation Strategy

You can use the alligator strategy as a confirmation (lagging) tool to identify a price trend. The alligator indicator validates whether a specific financial instrument is trending.

For example, if you are trading oil using binary options and observe that the price has declined over time, the alligator strategy might help confirm this trend.

By using the alligator indicator, you can confirm whether the oil is experiencing a downtrend by examining the placement of the SMAs. To verify a downtrend, the Jaw (blue line) must be above the Teeth (red line), and the Teeth must be above the Lips (green line).

If this arrangement is present, then a downtrend is confirmed, allowing you to position yourself to leverage this information and look for potential trade opportunities.

2. Divergence Strategy

You can also use the alligator indicator to identify potential trend reversals through divergence. The alligator strategy is particularly effective in pinpointing trends due to its straightforward and distinct use case. Therefore, you can apply this knowledge by searching for a “divergence” between the price and the alligator indicator.

Using the same oil example above, suppose you have successfully identified that oil is in a downtrend. A few days have passed, and the price continues to trend lower. Suddenly, you notice a shift in the alligator indicator: the Lips (green line) are now above the Teeth (red line), which in turn is above the Jaw (blue line).

This arrangement indicates a shift from a downtrend to an uptrend. Yet, when you look back at the price, it continues to decline. This discrepancy is your cue that the price might soon stop dropping and may begin to reverse. In this case, the alligator indicator is a ‘leading’ indicator.

3. Entry Signal Strategy

Lastly, although it may be unorthodox, you can use the Alligator indicator to establish specific entry signals for your binary options trades. This involves closely monitoring how the price reacts to the indicator’s three SMAs. To illustrate, let’s continue with the example from the second strategy.

Suppose you have identified a divergence and are now waiting for a potential trade entry for an oil binary option. You can observe closely how the price reacts to the “body parts” of the alligator indicator to find clues for pinpointing an optimal entry point.

If, for example, you notice that the price has been bouncing back after hitting the Jaw (blue line), this effectively indicates that the Jaw has now become a ‘dynamic’ support level. This information lets you plan your trade by waiting for the price to approach the blue line again.

Then, once you have identified a price action reversal pattern, this confirms a potential bounce, and you can then place a buy order.

Pros and Cons of Using the Alligator Indicator

Pros
  • Trend and momentum confirmation
  • Clarity of signal
  • Easy to interpret
  • High versatility
  • Dynamic support and resistance levels
Cons
  • Inherent lagging nature
  • False signals
  • Risk of overfitting
  • Risk of overreliance
  • Interpretation variability
ProsCons
1. Trend and Momentum Confirmation
First, it can serve as a trend and a momentum confirmation tool. When the price moves toward the alligator’s mouth, it signals that the momentum supports the current trend, providing added confidence in a trade.
1. Inherent Lagging Nature
First, despite its potential use case for divergences, the indicator is based on moving averages, which are inherently lagging. Hence, signals may be delayed and lead to suboptimal entries.
2. Clarity of Signal
Second, since the three moving averages representing the alligator body parts are color-coded, it’s easy to identify. This explicit visual representation helps to comprehend market conditions quickly without complicated analysis.
2. False Signals
Second, no technical indicator is perfect, and the alligator can also generate false signals, especially in markets with no explicit trend (consolidation). Thus, depending exclusively on the alligator can lead to costly trading decisions.
3. Easy to Interpret
Third, the indicator’s clear and simple signal makes it easy to understand, even for beginner traders. Moreover, the indicator’s visually intuitive nature makes it straightforward to interpret and apply in actual trades.
3. Risk of Overfitting
Third, traders may attempt to overfit the indicator on a given market condition in the guise of “optimizing.” Despite your best efforts, you may need help to make it work in your specific use case. It is crucial to realize that the alligator is also limited in use case and effectivity.
4. Highly Versatility
Fourth, the alligator indicator can be employed in various market conditions and time frames. Thus, the indicator can provide valuable insights even if you are trading extremely short-term binary options.
4. Risk of Overreliance
Fourth, due to its straightforward nature, you may become over-reliant on the indicator, neglecting other crucial market elements and signals. This can cause you to have tunnel vision and may lead to increased risk-taking.
5. Dynamic Support and Resistance Levels
Lastly, the three moving averages in the indicator can function as dynamic support and resistance levels. Hence, you can use these levels to identify potential entry points, which is especially valuable in binary options where timing is crucial.
5. Interpretation Variability
In various scenarios, traders may interpret the alligator indicator’s signals differently. This is particularly prevalent in social media, where traders find novel use cases of specific indicators.

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Alternatives to the Alligator Indicator

The following are some of the indicators that can function as potential alternatives to alligator’s functions:

RSI (Relative Strength Index)

RSI estimates the speed and change of price movements from 0 to 100. The indicator is also used to pinpoint overbought (a reading above 70) or oversold (a reading below 30) conditions.

Bollinger Bands

This indicator gauges market volatility and determines potential overbought or oversold conditions. Bollinger Bands consists of a “middle band” that is also a moving average (typically the 20-day moving average) and two “outer bands” (considered standard deviations) away from the middle band.

Moving Average Convergence Divergence (MACD)

One of the most well-known indicators, the MACD, measures changes in the momentum, strength, and direction of a trend in an asset’s price. It comprises two moving averages (the default setting is 12-day and 26-day averages) and a histogram that gauges the space between those moving averages.

Can You Combine the Alligator Indicator with Other Indicators?

Absolutely! As we have seen, RSI, Bollinger Bands, and MACD indicators have an overlapping purpose with alligators and may be deemed “redundant” when trading. Yet, you can combine alligators with other indicators to enhance your analysis’s accuracy and reliability.

A single indicator is more prone to false signals. Hence, combining two or more indicators allows you to filter out market noise and better time your binary options trade entries.

Conclusion

Overall, the Williams Alligator Indicator presents compelling use cases and benefits such as clear trend and momentum confirmation, straightforward trade signals, and overall versatility. Nonetheless, just like any other indicator, the Alligator indicator also has disadvantages and limitations that you must keep in mind to fully utilize it in your trading strategy.

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Most Asked Questions:

What is the Alligator Indicator?

The Alligator Indicator is a technical analysis tool used in binary options trading to pinpoint distinct price trends and their specific direction in any market. Moreover, it can signal the start of a new trend as well as the end of an existing trend.

What do the three lines of the Alligator Indicator represent?

The blue line is the alligator’s “Jaw,” which is the 13-period Smoothed Moving Average (SMA) and represents the longer-term trend. The red line is the alligator’s “Teeth,” which is the 8-period SMA and depicts the medium-term trend. Lastly, the green line is the alligator’s “lips,” a 5-period SMA representing the short-term trend.

How do I interpret the Alligator Indicator in binary options trading?

When the lines are intertwined, the market or asset you selected is considered in a ‘sleeping’ state, indicating a lack of trend. A bullish trend is displayed when the lines are detached, with the Lips above the Teeth and the Teeth above the Jaw. Conversely, the opposite alignment indicates a bearish trend.

How can I use the Alligator Indicator to make binary options trades?

Theoretically, you can enter a ‘call’ option when the alligator lines align upwards, demonstrating a bullish trend, and a ‘put’ option when the lines align downwards, indicating a bearish trend. Nevertheless, it is crucial to consider the option’s expiry time relative to the market’s momentum and the indicator’s inherent delay in your trade decisions.

Can the Alligator Indicator predict the future direction of the market?

While the alligator indicator can help you recognize potential trends based on past and current price action, no single indicator, including the alligator, can completely predict price direction. Thus, incorporating sound risk management principles would help if you remained prepared for unexpected market movements.

About the author

Marc Van Sittert
Marc Van Sittert is an experienced Binary Options Trader and coach who is originally from South Africa. He started his career in 2014 by trading old-school Binary Options online. His main focus is on short-term contracts with 60-second trades.

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