How and Why does Confluence Work in Trading?
February 3, 2020
a. What is Confluence?
Before we get into the details of how confluence can improve your trading, we first need to understand what it is.
The dictionary has the following definition.
Confluence: a situation in which two things come together or happen at the same time.
So essentially confluence represents two or more “things” coming together at the same time. In terms of trading Forex, we can say that confluence is when two or more factors come together at the same place on a chart.
Some examples of these “things” might be a key support or resistance level, supply/demand zones, moving average, price action buy or sell signal or even something as simple as a strong trend. All of these things form what we’ll call Confluence Factors. In other words, a strong trend might be one factor, price action buy signal might be a second factor and so on.
Now that we’ve defined what confluence is and how we can apply it to trading, let’s discuss why it’s so important.
b. How and Why does confluence work in trading?
If there are more people buying the Bulls than the bears at a period of time, the market will most likely go Bullish. And so forth if it goes bearish.
Therefore, forex trading is about understanding the market sentiments. “Where are the big guys with the big influx of money moving the currency market to?”
And this leads to CONFLUENCE.
Trader A trades only on Candlesticks patterns
Trader B trades only on Moving Average signals
Trader C trades only on Support & Resistance
Trader D trades only on Fibonacci signals
Trader E trades only on Divergence
Trader F trades only on News
Example: Trader D sees a Fibonacci signal which is strong and he enters it long. But Forex Trader E & A sees their signal and took it short. The market will most likely head short if there are more traders who took it short than long. The bears won the game.
From this example, you can see why Confluence is so important in forex trading and why professional forex traders enter only on confluence.
When we combine all the signals, and if they come together in the same direction. Then there is a very good chance that the market will move your way. Because all the forex traders see their signal (eg. long) and entered it. Regardless of which signals you see, it shows short. This shows that the more trading signals you get on your side of the trade, the higher the chance of winning.
Confluence puts the odds in your favor
Traders should keep in mind that there is no form of analysis that will predict future price movements. Instead, trading is about probabilities. The ability to put the odds in your favor is what trading is all about. Figure out a way to do this over and over again and you’ll be well on your way to becoming profitable. This is where the combination of various Confluence Factors comes into play.
For all intents and purposes, we can view confluence as putting the odds in your favor. In other words, the more Confluence Factors present on any given setup, the greater the odds are that the setup will move in the intended direction.
When a Forex trader utilizes the confluence concept, a trader can choose to filter out trade setups where multiple tools are not in harmony and in sync.
When we were kids, most of us had this dream job, to be a “Detective”. Well! You are essentially like a detective when you trade price action. The point is to gather many pieces of evidence/clues to back up your conclusion. A detective looks for fingerprints, examines records and documents, observes the activities of suspects and talks to witnesses and informants…
One evidence may be irrelevant or simply a coincidence, one witness can be lying. That is why detectives tend to gather as many evidences are possible before making a judgment and start interrogating suspects.
The same rule applies to Forex Trading, one or two signals are not enough to make a trade. We recommend at least three clues before calling it a potential trade.
As traders, our tools/clues are:
– Horizontal Support/Resistance Levels
– Psychological Levels / Round Numbers
– Dynamic Support/Resistance Levels / Trendlines and Moving Averages
– Supply/Demand Zones
– Candlesticks patterns
– Chart Patterns
– Overall Trend
– Fibonacci Retracements
– Event Areas
– Daily/Weekly Previous Highs/Lows
– Multiple Timeframe Analysis (more about this in the next section)
Less is More
A balance is a vital realization when trading confluence.
When a trader is looking for certain clues, it does not mean that all of them need to be aligned. Traders can look for a certain mixture of confluence, although this can be better achieved when trading with a discretionary method. Which mix is required can depend on the market structure to enhance results or the trader will fall into the trap of paralysis of analysis where multiple concepts are always contradicting each other.
A good rule of thumb: find 3 reasons to take the trade and make sure that there is maximum one but preferably zero reasons not to take a trade.