Technical Trading - Confluence
Growing up, I played a game where you had to swim to the bottom of the pool and collect as many coins as you could. Whoever had the most coins, (had the most money) won. The easiest way to win was to go where most of the coins were or at least where you saw the most coins piled up.
You’re probably thinking this has nothing to do with trading Forex markets, yet alone trading technical analysis with confluence, also known as confluence trading by the way. Bear with me!
Confluence has been defined by many as the use of several technical indicators that all give the same signal to either place a buy or sell on a trade. A combination of perspectives of the market or techniques in trading the Forex market.
Confluence may come in the form of chart patterns, price action, candlesticks and other indicators or tools such as the RSI (relative strength indicator), Stochastic, Fibonacci, or moving averages. As well as trend lines, channels, support and resistance zones.
Why is confluence so powerful?
Now that we have described what confluence is in the Forex markets, you’re probably wondering what that has to do with the story I told you before.
You see, when you dived in an area with many coins, the probability of you winning was unimaginably high, and when you have the most information agreeing to go in a certain direction, you know have an edge in the market, you can have a level of confidence to go that direction. Why? If you haven’t gotten it yet, well it’s because the probability is much higher in your favor now.
We have to have the patience for the market to come to us and not chase. That is why people focus on different aspects such as liquidity zones (where the supply is little but demand is high and vice versa), and other factors in the Forex market. You focus on confluences so that you are more accurate and hopefully over time greatly profitable.
At first, you may even be very confused as to how this is all happening but think of it this way, if there are a large number of traders who see what you see through a 200-daily MA on NZDUSD for example and are all thinking of selling the pair, that creates liquidity and maybe even a zone if the bias is indecisive and eventually a move to the downside. But instead of giving hypotheticals, let us take a look at the charts.
Below we find a USDCAD chart from the hourly and 30 minutes perspective. I had no bias in choosing the pair nor the timeframes, this is just for illustration purposes. Let’s jump over and have a look at the H1 timeframe first.
(Source – TradingView)
Earlier I mentioned not chasing the market and collecting as much evidence in favor of your analysis in order to have a high probability set up.
On this H1 timeframe we notice the downtrend, which is only confirmed after the second leg or impulse down, we also notice that what was support and is now resistance zone.
On top of that we have used an indicator that helps us look for buying and selling opportunities in the market; the Fibonacci retracement too (I hope you remember what I said about Fibs and what they could help you with… if not check it out, it will come in handy), and lastly we have that rectangular box around the candle sticks. “What?? That doesn’t mean anything, that isn’t significant!”
That may be the case, only if you don’t pay attention to detail, trust me. Let’s go one timeframe lower and have a look at what I’m talking about.
(Source – TradingView)
On this 30 minute timeframe of USDCAD, you will notice the beautiful language being spoken, oh so fluently! The story unfolding perfectly.
What I mean by that is, the first time we see it reaching the Fib zone as well as the resistance zone we see a beautiful evening star and right after it a hammer, signs of a reversal, and after that a bearish candle that takes out 2 almost 3 candles from the previous retracement.
However, you realize that this didn’t touch our trend line and so maybe you don’t want to enter that, which is okay because it comes back to touch our trend line and here we have an evening star, again, and a bearish engulfing candle which we could have entered on.
If we missed that opportunity the market presented us with another opportunity with the next 3 candles; a hammer, marubozu, and a special kind of Doji – called a gravestone Doji (which also supports bearish pressure). And there you have it. 4 different confluences and how they can be applied together to bring one unique sentiment in the market.
Please do not feel frightened and over complicate your own lives by trying to find a million different confluences to support your analysis because that makes it tricky. So if you are wondering what is enough in terms of the number of confluences? Most traders stick to 3 or and pull the trigger from that.
So in closing, go out and experiment, enjoy the wonders of having all the pieces of a puzzle come together and seeing the bigger picture. Keep learning, keep trying and keep growing.
Happy trading Traders!