Confluence in Forex is a concept that allows Forex traders to combine various technical analysis tools and instruments to judge whether any particular trade has better or worse odds of success. Basically, the idea mitigates the over-reliance on one tool.
Today’s article focuses on how using this technique can be a tremendous asset for any Forex trader.
WHAT IS CONFLUENCE TRADING?
Confluence trading forex means that a trader is analyzing whether various tools and instruments provide confirmation of support and resistance at a similar or same spot on the chart.
For instance, if a 50% Fibonacci retracement, a 50 period EMA moving average, a -61.8% Fibonacci target and a trend line all align themselves at one spot on the chart, then this is called trading confluence. There is a combination of elements joining together at one point on the chart.
When various tools and instruments are confirming a spot on the chart to be of importance, then the likelihood of price, in fact, reacting to this level increases. In general, price moves from one level of support to the next level of resistance, and it is the trader’s judgment to analyze which levels are worth trading. By having layers of confluence at one spot, the trader improves their ability to understand which levels are critical and worth trading. Please note that it is not needed to have all of the tools and/or indicators aligned or perfectly matching.
This technique is valuable for all types of traders:
1) It can be used on all time frames – from intraday up to position trades;
2) It can be used in both discretionary as non-discretionary trading strategies;
3) It can be used for (almost) all types of strategies and analysis.
ADVANTAGES OF CONFLUENCE?
Ultimately each concept used when trading should lead to an improved reward to risk balance in relation to the profitability. Trading confluence helps achieve that goal. How does trading confluence achieve that?
Simply put, the reason is this:
1) Each tool or indicator has an expected win rate, expected the reward to risk, expected drawdown. These expectations and averages vary from time to time, depending on the market structure. For instance, trending trades work great when the market is moving, but range traders are more successful when the market is having a slower day.
2) By combining tools and indicators, the trader is eliminating the weaknesses of each tool or indicator when used separately. Or in other words, the trader effectively decreases the risk of relying on one particular technique and thereby receives more confirmation for a setup. 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. The trader thereby increases the overall aggregate performance.
DISADVANTAGES OF CONFLUENCE?
Are there any disadvantages? Yes. The danger lurks when a trader overuses the concept and starts over combining tools and indicators.
When too many indicators and tools are used, the chances of all of the tools and indicators being aligned are far smaller. Besides the disadvantage that the chart will lack simplicity and clarity, the trader will fall into the trap of paralysis of analysis where multiple concepts are always contradicting each other.
Effectively the trader is looking for the perfect setup that has everything aligned and by doing so the Forex trader is actually filtering out all price action and thereby avoiding trading altogether. Although this will not cause loses, it would be impossible to make any gains.
FINDING A BALANCE IN CONFLUENCE
That is why finding a balance is a vital realization when trading confluence. A balance needs to be found in various elements such as:
1) The number of tools and indicators used: when too many tools and indicators are used the chart becomes cluttered and the process of analyzing them could be lengthy and vulnerable to interpretation mistakes. Also, the danger of paralysis of analysis is likely.
2) How many tools and indicators need to be aligned: when an FX trader is using certain tools and indicators, 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.
3) A good rule of thumb, which my mentor has always told me, is this: find 3 reasons to take the trade and make sure that there maximum one but preferably zero reasons not to take a trade. Remember everyone needs a mentor; make sure to get one yourself. If you are looking for a mentor please click here.
HOW TO TRADE CONFLUENCE
After going through paragraphs above, it becomes obvious that a confluence trading system is a major benefit for Forex traders and thus recommendable in most cases. The goal is the find a balance and equilibrium when using confluence which matches and fulfills the various goals each one of us has formulated. Multiple time frame analysis can be used for trading confluence as well but be careful with over combining time frames to avoid the paralysis of analysis, overcrowded charts, and excessive filtering out of trade setups.
Each trader has strategies that accumulate to a certain winning streak, losing streak, a number of opportunities per day/week/month, drawdown, win percentage, loss percentage, average win, average loss, profit, etc. By either tightening or weakening the level of trading confluence, the trader can tighten or loosen the number of opportunities and alter the equity curve to meet the expectations and goals of the trader.
Another element that requires attention is whether there is potential syn-energy between various tools and indicators – or a complete lack of it. For instance, using an oscillator to measure whether the trend has reached a position of oversold or overbought would make little sense as the trend can push further than a trader expects (looking for divergence, however, is a different story and does make sense). However, using Fibonacci retracements and targets to see at which levels the two do match and meet make perfect sense and is a great example of trading confluence using well matching tools.
In our trading room, we are certainly a regular user of trading confluence. Our tools and indicators are geared towards finding areas of with trend continuation setups. For that purpose, we use EMA’s, Fibonacci, trend lines & channels, 1 oscillator (to measure the presence of divergence), price action (momentum/correction), candlesticks, and chart patterns. Each of these tools has their own specific moment in the sun and certainly, not all tools are employed at similar moments. Each tool and indicator has their specific use depending on the stage of the TOFTEM model. For more information what is technical analysis, join our trading room!
Do you use confluence in forex? Do YOU have a rule of thumb when looking for confluence? Let us know down below!