Apply the tm Alligator indicator to your end of day chart.
Watch for a crossover. A bullish cross over must open below the three Alligator lines and close above them on the same day. We repeat that this should happen on the same day. You may relax the rules a bit, to permit a composite (across two days) cross but to be honest I prefer those that happen all in one day. No hesitation normally means that the stock is going to go up. Note that the direction of the three lines or even their order is not considered.
If you are tracking the market during trading, you can buy before the close. otherwise, buy the next day. Put your stop (mental or actual) below the candle that crossed and let them run.
Exiting a cross over is up to you – I expect 3% to 5% and after that everything is golden. My stop is always just below the crossing bar because the beauty of the cross over is – it works or it doesn’t. I use a close as a trigger to sell the stock. In other words an intra-day move below the candle will not cause me to sell but a end of day close below the candle definitely will. While some traders accept a pull back, I prefer the ones that go straight up.
Such crossovers will not come often. I think, we get one in two months, on an average. But, remember there are many stocks to swing trade, so there should be a stream of such patterns coming in. Remember, patience is the best friend of the trader. And impatience is the reason why many traders go broke instead of rich.
If you are trading in Futures, you can also go for the short sell signals. This will increase the number of signals that come in. A bearish crossover takes place when price opens above the three lines and closes below it. The stop is above the high of the crossover day.
The theory behind the Alligator lines is simple. When the lines converge it suggests that volatility is damping out and when they diverge it suggests that the volatility is excessive and needs to come back. A crossover will normally happen when the lines are converging. The crossover is giving a message that the decline in volartility may be over.
So instead of looking at the three lines as just three more lines on a chart – start looking at them as a function of volatility and they might start making more sense to you.
You may also experiment with replacing the Alligator lines with three moving averages to your end of day chart – the 4, 8 and 21 EMA. I have found the Alligator to be a better method.
