Bill Williams Strategy

Although their indicators may be quite well known, especially since they come standard in
Metatrader (do you recognize the Alligator or the Awesome Oscillator?), the truth is that Bill Williams is a
little-known author in these parts despite having had his moment of glory in the US. Author
from the best-seller Trading Chaos: Applying Expert Techniques to Maximize Your Profits, Bill Williams
has over 50 years of experience in the markets (in fact, it has recently been
retired and has passed the business to his daughter) and is the founder of Profitunity Trading Group, since the

that different courses and seminars are organized. It could be said, by analogy, that it is a
species of Antonio Saez del Castillo in the American style :)

However, although we might suspect that this is just another hair growth seller, with the
advantage of writing in English, and that his books exude a certain cunning (despite the fact that the title
In his most famous book, he mentions the word chaos; the theory of chaos is only discussed in one instance.
twenty pages), the truth is that their way of seeing the market can provide us with some ideas
interesting ones that we can incorporate into our trading. In this first installment we will see the

foundations of Bill Williams' theory, which will later be specified in different

indicators that we will dissect in upcoming articles.

For Bill Williams, the definition of the market is simple: it is that mechanism which, in a quick way
and efficient, allows us to identify those points where there is disagreement in value and
agreement on the price. However, the operation of said mechanism does not fit within the
traditional mathematical model of the Gaussian bell, but it is much better examined from
the optics of the new paradigm of chaos theory and nonlinear dynamic models. Although
our education teaches us that "truth" is found in the stable, the linear, the certain is that
stability is temporary and chaos is eternal. If we had to recreate the world from a perspective
linear, we would have straight rivers, round clouds, and cone-shaped mountains. However,
we know that the world does not work this way, but that it is nonlinear. Nature and markets
they behave similarly to that of a river: in a current we are unable to predict the
trajectory of a water particle as the current is, at the same time, continuously changing and
always stable: if we throw a stone into the water, the system will not destabilize. In a chaotic system
everything is influenced by everything, but at the same time the subtle interconnections that are formed give

stability to the set. But this stability is extremely fragile since any change
initial conditions can lead to very disparate behaviors, thus producing
apparently random behaviors.

Evidently, in a world and markets governed by the rules of chaos, we cannot

to pretend to make money using linear methods and strategies. Taking into account that the body
the human is built on the basis of fractals, it seems reasonable to think that any pattern
derived from human interaction, as is the case with markets, is also of a nature
Fractal. The market is the product of the psychology of the masses, which is composed of the
fractal structures of the minds of thousands of traders. Therefore, our goal in trading
it should be to find the fractal structure that defines the market to understand its
behavior.

The theory of chaos offers us three fundamental principles to study our way of acting.
in the markets:

• Energy always follows the path of least resistance. The market is like a river: to
as it moves, advances along the path that offers the least resistance. Even the
traders follow this principle: when we notice ourselves tense in the operations, it is likely that

debate about whether we are moving against the path of least resistance.

• The path of least resistance is always determined by a structure.

underlying that is generally hidden. The behavior of the river depends on
complete with the underlying structure of its bed, so we will only be able to predict if
there will be rapids or the water will be calm analyzing the riverbed. In the same way, the
the underlying structure of our life determines how we approach our trading and how
We react to market movements.

• The underlying structure can be discovered and altered. Attempt to change the course of the
river (market) using buckets is an impossible task. However, if we ascend to
the birth of the river we will be able to completely change the course of the same movement
few rocks to make the water flow in a different direction. A slight change can
have important consequences on the behavior of phenomena and in our
attitude towards trading.
Therefore, we can first learn to recognize the underlying structure that guides our
trading and changing it to achieve what we really want from the market. Such structure can
to be of two types:

• Type 1 Structure originates in the left hemisphere of the brain and produces
action-reaction type behaviors: a desirable behavior leads to another
opposite and undesirable, similar to a pendulum. Traders are often immersed
in structures of this type: let’s suppose we start an operation and we want to be
we set a very tight stop so that, if we
we're mistaken, it won't hurt us too much. The market undergoes a normal correction and rebounds

the stop, then continue in the expected direction. We analyzed the loss and decided that
our stops are too tight and we must give the market some leeway. In the
next operation we set a distant stop; the market turns and hits the stop producing
a huge loss. We analyze the result again and tighten the stop again.

In this type of structures, psychological help will not work because it will not correct the structure.

underlying, it will only temporarily solve the problem. If a trader detects this type
in structure in its operation, the best thing it can do is to stop operating until it achieves
change it.

• Type 2 Structure, based on the right hemisphere, is oriented towards the action of creating.
Instead of trying to solve problems by opposition as in Type 1 Structure,
we try to create results. When we solve a problem, what we achieve is the
absence of the problem; but this does not imply achieving the desired objective. As traders,
Do we want to solve problems (eliminate losses) or create results (make money)?
When a trader responds to the current circumstances, they become trapped by them.
while when he is creating he is free and does not feel threatened. All our lives
they have told us what, when, where, and how to do things; but when we started in the
In trading, there are no rules: we can operate whenever we want, with the amount and the risk.
that we desire, thus creating our benefits. For this reason, people are usually not
properly educated to trade. They subscribe to signal services or watch the
CNBC in search of guidance, of directives. They do not realize that the guidance is
inside ourselves.
Ultimately, for Bill Williams our profits are determined by our psychology
what anyone can gain in the market as long as they are able to discover what it is
structure that governs their behavior. Trading is a psychological game, so we must
get to know our trader 'self' better.

Likewise, apart from getting to know ourselves better, the second key aspect to win in
The market is to understand the market structure. Technical analysis and fundamental analysis.
they are not enough to obtain consistent profits because they do not analyze the true structure
underlying the market; in fact, these are methods of analysis that are not valid for systems
nonlinear dynamics such as markets. According to Williams, we can encompass the structure of
market analyzing its different dimensions, which are:

• Fractal (phase space)

• Momentum (phase energy)

• Acceleration / Deceleration (phase force)

• Zone (combination of energy and phase strength)

• Equilibrium line (strange attractors)

The Fractal Pattern by Bill Williams is a geometric pattern that can be observed in any
timeframe, whether 1, 5 or 30 minutes, an hour or daily. This pattern consists of at least 5
consecutive candles in which the middle candle shows a higher high (or a lower low)
than the two candles before and after.

In particular:

• We will have an Up Fractal when the maximum of the intermediate candle is greater than the

maximums of the two previous and subsequent candles.

• We will have a Down Fractal when the minimum of the intermediate candle is lower than the
minimums of the two previous and subsequent candles.

It is worth noting that Fractals have some restrictions to consider:

 • If the maximum (minimum) of a candle coincides with that of the intermediate candle, that candle does not

will be part of the pattern since it will not have a higher maximum (lower minimum) than the candle

intermediate.

• Two adjacent fractals can share several candles

Therefore, considering these, we could have different variants of the pattern such as those that
they show below:

We can use Fractals in our trading in different ways:

• A primary use is to use them directly as levels of support and resistance.

uniting several of them.
• In the same way, they facilitate the plotting of trend lines.
 • Finally, using Fractals we can determine the validity of a trend or if the
The market is consolidating levels. Thus, in an upward trend, we will see that they break.
more Up Fractals than Down Fractals, while a downward trend will occur the
on the contrary, breaking defined supports most of the time set by Down Fractals. By
On the contrary, if the market is unable to surpass previous fractals, as shown.
in the following chart, we will say that the market is in consolidation and, therefore,
there is no dominant trend.

With these elements, Bill Williams proposes a trading strategy based on Fractals in his book:
the idea basically consists of taking a consecutive Up Fractal and Down Fractal and placing a stop
to buy a tick above the maximum of the Up Fractal or a sell stop a tick below it
minimum of the Down Fractal. Once the entry order is executed, our stop loss will be
located in the Fractal Up whose maximum is greater than the last two that have occurred (if
we have entered short, as in the example shown below) or in the Fractal Down
whose minimum is lower than the two most recent. The exit is defined by a trailing stop
calculated from the initial stop that we will move as new ones are formed
fractals.

In the following example, an operation using Fractals in the USDJPY is shown. Once the price
breaks down the Down Fractal, we sell at 118.96, one pip below the minimum. Taking as
reference the two Up Fractals that have occurred before the entry, we see that the highest peak
of the two, it is the one from our initial Up Fractal.

However, when trading with Fractals, we must keep in mind that it is an indicator.
that repaints, that is, it can be recalculated and vary when we close and open a chart.
that, as far as possible, we should work with levels calculated beforehand in the historical data
from the graph, with recent Fractals that have appeared being unreliable (we must have
Keep in mind that we need at least 5 candles to form the pattern, so we would have to start.
to consider fractals that have formed at least 6-7 candles before.

On the other hand, in the context of Bill Williams' theory, Fractals only define the space.
of phase, but they do not tell us anything about the strength and energy of the movement.

We continue with the second dimension within Bill Williams' methodology, that of Momentum.
(phase energy). Before starting, it is important to remember that the first signal to consider
it is always the Fractal we saw in the previous article, discarding all others as long as not
confirm this signal from the first dimension. Once we have opened a position in the direction
indicated by the Fractal, we must add positions each time a signal occurs in others
dimensions.
To determine market momentum, Williams uses the Awesome Oscillator, which shows
through a histogram the difference between the simple moving averages of 5 and 34 periods calculated
using the midpoint of the candles, that is, (Maximum + Minimum) / 2.

Graphically, the indicator looks as follows:

Basically, we can obtain three types of signals with this indicator:

1. Awesome Oscillator Saucer. In this case, buy signals are generated when the
histogram, being situated above zero, changes color from red to green following a
three-bar pattern in the histogram that verifies the following conditions:

• The first bar of the pattern (a) can be any color and its value is greater than that of
the bar (b).

• The bar (b) must be red.

• The bar (c) must be green.

The following graph shows a graphical example of this pattern:

Once the pattern is confirmed, we will place a buy stop one tick above the maximum of the
candle in which the bar (c) is confirmed.

Of course, for the case of sell signals, it is enough to reverse the conditions of the pattern. Thus,
assuming that the histogram is below the zero line, it would have to be met that:

• The first bar of the pattern (a) can be any color and its value is lower than that of
the bar (b).

• The bar (b) must be green.

• The bar (c) must be red.

The more recent Saucer-type signals override the previous ones, so it is advisable that we do not
let's forget to cancel any order we have left pending.
2. Awesome Oscillator Zero Cross. This may be the signal that becomes most evident when
We open a chart and insert the indicator for the first time. Basically, it is about buying.
when the histogram crosses above the zero line and to sell when it crosses below that level.

Once the signal is confirmed, we should place a buy stop (sell stop) one tick above.
from the maximum (below the minimum) of the first candle in which the line crossover occurs
zero.

3. Twin Peaks. Finally, the third signal that we can generate is obtained, in the case of the
purchases, when the histogram is below the zero line and two increasing minima. Of the same
Thus, in the case of sales, we will have a histogram above zero and two peaks.
decreasing. In the following chart, both patterns are clearly visible:
In both cases, between the minima or maxima of the histogram, a crossing cannot occur.
the zero line. Once confirmed, we must place a buy stop one tick above the maximum,
or a sell stop one tick below the minimum in the case that the signal was a sell, in the
candle that confirms the signal.

Finally, one last recommendation for trading with the signals from this indicator: you should never
buy with a red histogram bar nor sell with a green histogram bar. And in the
in case we had set a stop to enter the market and a sign bar occurred
Contrary to the direction we expect, we must discard the entry and cancel the order.
immediately.

According to Williams, before the price behavior changes, momentum does; and before
that this changes, there will be a variation in its acceleration. The acceleration or
The deceleration of the current market momentum is measured using the Acceleration / Deceleration.
Oscillator.

The values of this oscillator are obtained by calculating the difference between the Awesome Oscillator and its

simple moving average of 5 periods.

En la práctica el Acceleration / Deceleration Oscillator tiene el siguiente aspecto visual:

The green bars appear in the histogram when their value is greater than the previous one while
Red bars occur when the value of the bar is lower than the previous one.

The interpretation of this oscillator is different from that of the Awesome Oscillator. Thus, if the Acceleration /

Deceleration Oscillator crosses the zero line upwards or downwards, no signal is generated, although
we will never buy if a red bar appears on the histogram or we will sell if the bar is green.

Basically, when working with this oscillator, we must take into account two patterns:

1. Buy above the zero line / sell below the zero line. When the histogram
is above the zero line, we will have a buy signal when two occur
consecutive green bars on the histogram. In that case, we should place a buy stop at a
tick above the maximum of the candle where the second green bar appears. In the next
In the graph, we can see an example of this signal.
Similarly, we will have a sell signal below the zero line when two appear
consecutive red bars in the histogram. At that moment we will place a sell stop below
from the minimum of the candle in which the second red bar is produced.

2. Selling above the zero line / buying below the zero line. In this case, we will have
a buy signal when three green bars occur when the histogram is below
from the zero line. Just like in the previous case, we will place a buy stop one tick above
from the maximum of the candle where the third green bar appears. Graphically, the signal would be the
next:
On the contrary, if the histogram is above the zero line and three red bars appear
Consecutively, we will have a sell signal, and we should place a sell stop one tick below.
from the candle where the third red candle appears.

About this second pattern, Williams makes the following observation: if the first or second bar
they will cross the zero line, it would not be necessary to wait for the third bar, considering the second bar
the reference to set the stop. That is:

• If the first or second green bar crosses above the zero line, we should place a stop.
buy a tick above the candle where the second green bar occurs.

• If the first or second red bar crosses below the zero line, we should place a stop.
for sale a tick below the candle in which the second red bar occurs.

Finally, when using the signals from the patterns we have just seen, we should not
forget that:

• We must ignore those signals that do not go in the same direction as those generated by
the fractal.

• If the Acceleration / Deceleration Oscillator generates a signal, but the histogram changes from
color before the pending order is executed, then we should ignore the signal and
cancel the order immediately.

When the Momentum phase (determined by the Awesome Oscillator) and the Acceleration phase (measured
for the Acceleration/Deceleration) coincide and point in the same direction (that is, they are both
green or red indicators), it will not be indicating that the market momentum is accelerating
in the right direction. In a situation like this, we will say that the price has entered the Zone (the fourth)

dimension within the methodology of Bill Williams.

In particular:

• If the bars of both histograms are in green, we will say that the market is in
in the Green Zone so the market is bullish.

• If on the contrary both histograms are in red, then the market is in the Zone
Red, because the market is bearish.
 • Finally, if each histogram presents a different color, then the market will be in
the Gray Zone, so we will say that the market is in transition.

In the following graph, you can see an example of the three zones. Although the graph shows them as
in consecutive form, it does not always happen like this:

The rules for adding positions using the different zones are as follows:

• To open long positions in the Green Zone, at least two green bars must occur.
followed in both histograms and the close of the second candle must be higher than the close
from the previous candle.

• To open short positions in the Red Zone, at least two bearish bars must occur.
followed in both histograms and the close of the second candle must be lower than the close
from the previous candle.

• If more than 5 bars of the same color were produced in both histograms (something
completely unusual), we would stop adding positions and set a stop one tick by
below the minimum (if we are long) or above the maximum (if we are short) of the
fifth candle. If the stop does not execute, in that case we should keep moving the stop to the
next candle.
In any case, we must not forget that the first signal to always consider is that of the Fractal.
What we saw, discarding all others until the direction of the first is confirmed.
dimension. Therefore, the signals from the Zone should only be used to add positions.

Within Bill Williams' methodology, the Balance Line is the level at which price
it would be if new information did not enter the market. As new information arrives at the
market, it is easier (requires less energy) for the price to move away from the Line of
Balance that approaches her (in Williams' words, "it is easier to go downhill than
uphill

To better understand the concept, let's look at the following example:

In the previous graph:

• Buyers weaken at bar 'b' compared to bar 'a'. Test of

It is noted that the maximum of bar 'b' is less than that of bar 'a'.

• Why do the vendors dominate bar 'b'? The reason is that new has entered
information to the market (highlighted by the square situated above the maximum) that has
changed the market balance.

• If buyers regain control and push the market up (as in bar 'c'),
reaching the maximum of bar 'a' will indicate to us that the balance of
the market has changed and the time to open a position is probably coming
within the fifth dimension.

About this idea, Williams defines the concept of base bar:

 • In the bullish case, a base bar is the most recent bar on the chart whose high is lower
than that of the previous bar (such would be the case of bar 'b').

• In the bearish case, a base bar is the most recent bar on the chart whose minimum is higher.
than that of the previous bar (such would be the case of bar "c").

Determining the Balance Line: the Alligator

To determine the Market Equilibrium Line, Williams uses what is possibly his
the most well-known indicator, the Alligator. This indicator consists of three lines (see chart):

• The blue line (the Alligator's Jaw) is the Equilibrium Line for the time scale.
It is calculated as a smoothed moving average of 13 periods shifted 8 periods.
forward).

• For its part, the red line (the Alligator's Teeth) is the Balance Line for a scale.
lower than the current one. It is calculated as a smoothed moving average of 8 periods.
shifted 5 periods forward.

• Finally, the green line (the Lips of the Alligator) is the Balance Line for a scale
lower temporal than that of the Alligator's teeth. It is calculated as a smoothed moving average
of 5 periods shifted 3 periods forward.

Williams describes the functioning of the indicator in a quite metaphorical way: "when the
Jaw, the Teeth and the Lips of the Alligator are intertwined means that the Alligator is going to
to fall asleep or that has already fallen asleep. As more time passes asleep, it becomes more and more

hunger. The first thing the Alligator will do when it wakes up is open its mouth and yawn. Then
the smell of food will reach its snout (bull meat or bear meat) and the Alligator will start to
hunt it. When it has eaten enough to feel full, the Alligator will start to lose interest.
for the food (the price) and the lines will begin to come together again, so it will be the time
to take benefits.

The fundamental idea of the Alligator is to indicate the current trend of the market. In particular:

• If the price is above the mouth (the three lines) of the Alligator, the trend will be bullish.

• On the contrary, if the price is below the mouth (the three lines) of the Alligator, the
the trend will be bearish.

Likewise, taking the blue line of this indicator as a reference (the Equilibrium Line of the
current time scale) and combining it with the concept of base bar, we can define the
the following patterns to generate buy and sell signals.

Buy above the Equilibrium Line

We will have a buy signal above the Equilibrium Line when the price rises above.
above the maximum of the most recent bar whose maximum is higher than that of the base bar
recent. When a buy signal of this type occurs, we must wait for the price to
move even further away from the Equilibrium Line.

Perhaps the previous idea may sound a bit convoluted, but with an example I think it is understood.
perfectly
Observe the previous graph: bars 1, 2, 3, 4, and B can be considered base bars that
They can potentially trigger a buy signal, as they all have a maximum.
decreasing compared to the previous bar.

As the market moves forward, we should place a buy stop one tick above the
maximum of each bar that precedes a base bar whose maximum is decreasing. Logically,
With the appearance of a new base bar, we must remove the previous stop and place a new one.
order. Since the most recent base bar on the chart is B, our buy stop will be
situated a tick above the maximum of bar 4.

We will maintain that stop in the market unless a new bullish base bar occurs.
whose case we should update the possible entry point) or the stop is reached. In our
For example, the buy stop is executed on bar 6.

Buy below the Equilibrium Line

We will have a buy signal below the Balance Line when the price rises above
above the highest of the two relevant maxima that precede the latest base bar. When
a buy signal of this type occurs, we must wait for the price to return to the Line of
Balance.

Let's see an example of this pattern:

As we can see, examining the chart from right to left, we find that bar B is
the base bar being the most recent bar whose maximum is less than that of the preceding bar.

We will have a buy signal below the Equilibrium Line when the price exceeds the
maximum of bar 1. This is so because the relevant previous highs before the base bar are those of
bars 1 and 3 (bar 2 is not taken into account due to having a maximum lower than the rest of the
candles), so our reference is the maximum of bar 1 for being greater than that of bar 3.

Therefore, we should place a buy stop one tick above the maximum of bar 1.
stop should not be modified unless a new base bar appears; finally in bar 6
the stop is reached and we enter the market.

Sale below the Break-Even Line

The determination of sell signals below the Equilibrium Line is analogous to that of the
buy signals above that line. In this case, we will have a sell signal for
below the Equilibrium Line when the price falls below the minimum of the bar more
recent whose minimum is lower than that of the most recent base bar. When a signal occurs
For this type of sale, we must wait for the price to move away from the Equilibrium Line.

Sale above the Break-even Line

Following the analogy, we will have a sell signal above the Equilibrium Line when
the price falls below the lower of the two relevant lows that precede the base bar
most recent. When a sell signal of this type occurs, we must wait for the price
retrace to the Line of Balance.

Some general rules when trading

Bill Williams recommends keeping the following general rules in mind when trading.
with its indicators:

Any signal we obtain with the indicators we have seen so far must be
ignored until a buy or sell signal is activated in a Fractal. This signal must always
it can also occur outside the mouth of the Alligator.

Once a signal is activated in the Fractal, we should only follow the rest of the indicators.
those signals that point in the same direction as the initial one obtained in the Fractal.
 2. One should never sell above the Alligator nor buy below it.

3. If the market is strongly moving in one direction, it is advisable to close positions if the price
turn and close crossing the teeth of the Alligator (red line).

4. If there is volatility in the market, it is advisable to place stop-losses on the lips.

from Alligator (green line). We will say that a market is volatile when the angle of the price
is greater than that of the Alligator's lips.

5. If the fifth consecutive bar of the same color appears in the Awesome histograms.
Oscillator and the Acceleration/Deceleration, we should place a stop at the red line.

6. We will always close open positions when a contrary signal occurs in the
Fractal. Likewise, it is advisable to be aware of possible divergences between the price and the

Awesome Oscillator could be signaling the end of the current trend.

Tying concepts

Let's look at a simple example of trading following Bill Williams' methodology. In the following
In the image, we see a chart of the EURUSD pair for the period between April and November.
2010 with all the indicators we have been analyzing in the previous articles:

As we can see, a buy operation is executed by jumping the stop 1 pip above the
maximum of the candle in which a Fractal is formed. The entry point is set at 1.2918.
Likewise, the buy signal is very strong as it is accompanied by:

• A bullish crossover of the zero line on the Awesome Oscillator

• An upward cross of the zero line in the Acceleration/Deceleration Oscillator

• With both histograms, the market is in the Green Zone, reinforcing still
more the bullish signal of the Fractal

• Furthermore, the price has closed above the mouth of the Alligator, so it could be
waking up to hunt, producing a strong bullish rally.

For all these reasons, due to the strength of the signal, we should enter the market with a
volume at least 3 or 4 times higher than usual. Subsequently, with the emergence of the second
Green Zone, we should add an additional position at the close of the candle that coincides with the
second green bar of the histogram of both oscillators.

In mid-October, several fractals are formed as the price begins to move in a way
lateral. Finally, on October 19, the price confirms a bearish signal in the Fractal, having to
automatically close the long position and open a short position, although with less volume than the
previous since there are not so many indicators pointing in the same direction. The benefit obtained
In this operation, it is 855 pips, a result that does not seem far-fetched considering the strong signal.
of purchase that originates the subsequent movement.