My Alligator Strategy for Swing Trading

 

There are all sorts of stats out there for how much time markets spend trending, compared to being stuck in choppy sideways conditions, but the reality is that one man’s trend is another man’s whipsaw. It really comes down to the timeframe and the metrics you’re trading with.

However, what’s really helpful in trading is a tool which will show where the trends are and where the chop is, so you can apply it within your timeframe.

The alligator indicator promises to do exactly that.

Today I want to show you how it works … where it falls short … and how to make it work for you in combination with a momentum indicator …

So, what is the alligator indicator?

The alligator indicator is nothing fancier than a series of offset moving averages applied to your chart.

• The Lips: a green 5-period smoothed moving average, shifted by 3 periods to the right
• The Teeth: a red 8-period smoothed moving average, shifted by 5 periods to the right
• The Jaws: a blue 13-period smoothed moving average, shifted by 8 periods to the right

The three lines represent the bite of the alligator against the price levels – first contact comes with the lips, then teeth, then conclusively with the jaw.

When the three moving averages are aligned – we have the alligator in feeding mode. When the three moving averages are intertwined, the alligator is in sleeping mode.

The ‘feeding phase’ represents the trending phase of the market.

The ‘sleeping phase’ tells us there is no clear trend.

It all sounds very neat, and when we apply it to a chart, we can clearly see the sleeping alligator vs the feeding alligator …

So, how do we apply this to the markets?

The alligator feeding frenzies look very clear in retrospect, but in reality, when the candlesticks are coming at you from the right of your chart, it’s not so simple

Moving averages are, by their nature, lagging indicators. Add to this the offset applied by the alligator indicator, and we get very slow reactions.

If we wait for our three moving averages to move into alignment, we’ve often missed a good chunk of, if not all of, the price move.

While slow indicators can be frustrating – they can serve a very useful purpose. Especially if we’re asking them to do the right job.

Shifting moving averages to the right might seem a curious thing to do, which is just going to make them even more glacial in their reactions, but what it does is offer a very solid support/resistance buffer in trending markets.

Here’s how it works …

Rather than act when our three moving averages to come into alignment – this is our cue to start looking for pullbacks, so we can get in as the price swings back into the trend.

In the image above, we can see the Alligator indicator coming into ‘feeding’ mode – but this isn’t the moment to enter. Instead, we want to wait for a pullback to the resistance of the green or red line (the lips or teeth of the alligator). We want to enter as the price accelerates away from this resistance level, as it does at A.

You’ll notice there’s another pullback at B on the chart above, which fails, with the price moving up through all three moving averages, and changing direction. We should be prepared for this – and this is where the Alligator indicator can help again – with clear, dynamic areas of support/resistance. We can tuck a stop level in behind the red or blue lines to give a quick exit if the price doesn’t go our way.

But the alligator indicator is really crying out for a sensitive momentum indicator to pair it with. That’s how to build this into a workable trading strategy.

The Alligator Trading Strategy

This strategy uses the alligator indicator for direction as well as support and resistance levels, backed up by momentum.

On the image below, I’ve added a momentum indicator. I’m waiting for:

• the Alligator indicator to come into alignment

• the price to interact with the green or red moving average or to see a false crossover of these two lines

• to see a crossover on the momentum indicator, suggesting that momentum is growing in the direction of our move

On the image above, we also get an overbought signal as the price bumps up against the resistance levels – I wouldn’t get too fixated on this. If we’re in a good strong trend (as the Alligator indicator should be showing us), overbought/oversold readings become very unreliable.

Here’s another example, where we have a long period of ‘feeding’ from the Alligator indicator …

What we want to catch is the moment when the price has pulled back to the ‘lips’ of the alligator and has closed above the green line again … and we want to back this up with a sign that momentum is behind this, with a bullish crossover on the oscillator.

You’ll see that where we have momentum behind the move, the price accelerates away from the alligator indicator, back into the trend. Perfect for catching big moves, and big profits.

How to apply my Alligator Strategy

This Alligator strategy works because we’ve accepted the glaring weakness of the alligator indicator, rather than asking this tool to do something it’s just not designed for. And we’ve plugged that weakness with a complementary indicator.

This means that we can clearly see when markets are pulling away in a trend, and when they are pulling back. Of course, there are grey areas, but if we watch for trend and momentum, we get the best chance of success.

Add into the mix the dynamic support and resistance levels that the Alligator indicator draws onto our charts, we can also practice good risk management with the high reward-to-risk ratio that trend trading demands.

I look forward to hearing how you get on with it.

 

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