TGIFF #014: Trading With Confluence

In this week’s newsletter I want to talk to you about the importance of trading with confluence.

Firstly, let me take a moment to explain what confluence is.

In a nutshell, in the context of trading, confluence is simply combining more than one trading technique or analysis to increase your odds of winning a trade.

In other words, it means having more than one factor present, before you enter the market.

For example, entering the market just on a signal alone is not enough; to give your trade decision more weight, you need more than just a buy or sell signal. 

The more evidence you have, the more factors that support the signal - which means you are entering the market based on confluence.

To become successful as a foreign exchange trader, you need to have an edge that enables you to make a consistent profit. 

An edge that will allow you to earn enough money when you are winning, and lose less than your winnings, when you end up losing money on a trade. 

Trading with confluence can give you the increased edge that you need to succeed in the forex market.

A technical confluence occurs when you find a trade setup using multiple technical analysis. 

When all these independent forms of analysis come together, you have put yourself in a very high probability situation to determine the future track of the market.

 There are many ways that a trader can apply the concept of confluence into their trading.

For me, I look for 5 confluent factors to aid my trading decisions.

For now, let’s look at the minimum 3 confluent factors that need to be present before I enter the market. 

If nothing else, traders, I want to encourage you to look for these 3 confluent factors before you enter the market (now, if you have more than these three factors, then that’s a bonus) and we will discuss other confluent factors, but in my view these three must be present or I don’t enter.

These are: Trend, Level, Signal.

If you have been trading for more than one day, you know the easiest, most reliable way to make money is to trade in the direction of the underlying trend. 

So the very first thing we do is determine the trend, whilst this newsletter is not a tutorial on how to determine the trend, you need to ask yourself what is the long term trend of the market, long term being 1 year or more. 

Simply zoom out of your charts and look at the weekly time frame to get an overall macro view of the historical movement of the market. 

If you see price has been trending for a year or more in either direction, then straight up you know at some point you would be looking to enter the market in alignment with the underlying trend. 

Of course, if you are unsure how to determine the trend of the market, then this is where you are at, and as we all know this is the very first technical skill you need to master.

So, let’s assume you know how to determine the trend of the market. What we want to do next is to identify key event areas, event areas are represented by previous significant support or resistance levels or more accurately support or resistance areas or zones. 

These are areas on your chart where price has repeatedly revisited and has reacted from these areas.

Again, if you do not know how to correctly identify support and resistance zones, then this is a critical skill that you must master because everything flows from support or resistance zones.

Once again assuming you know how to determine the trend and you have marked the major support and resistance zones on your charts, all you do now is wait for a price action buy or sell signal to form at or around these key event areas.

In short, you should only enter the market on a price action signal that you know intimately as opposed to entering the market on every price action signal that you have come across.

So, if you are trading in the direction of the underlying trend, or

if your price action signal has formed either at or around static horizontal support or resistance or dynamic support or resistance, 

then in most cases, that’s about as good as you are going to get and you should enter the market confidently and without hesitation because you have the 3 biggies all lining up telling you to enter.

If the trade fails it has nothing to do with your analysis, it is simply a result of the random distribution of winners and losers.

One More Factor to Consider

Assuming we have these 3 factors, which is enough by the way, what else can we look for to see if there is anything else of relevance to give our decision to enter even more weight?

Well, there are a couple more!

The first is using the only indicator you need which is the EMA’s exponential moving averages.

In essence, if your price action signal - be it a reverse signal or a continuation signal - forms at a horizontal support or resistance area and is also showing rejection or support where it reacts or respects dynamic support or resistance being the EMA’s, then you have another confluent factor telling you that price once again is respecting the mean, meaning price has revisited an area where it is comfortable and the EMA’s are a moving average which tells you an area or price point where price has repeatedly reacted from. 

Now a tip on EMA’s: The time horizon and the style of your own trading are decisive for selecting the right moving average. 

Those who hold trades for longer and don’t want to be pushed out of the market due to the initial smaller correctional movements typically choose a higher number of periods for their moving average. 

However, those who are day traders, who tend to react quickly to price fluctuations and want to enter and exit the market many times per day, are better off with a shorter number of periods. 

So, if you’re a day trader, 8 to 10 periods are popular because the moving averages react quickly to price.

If you are a swing trader where a longer-term view and strategic thinking is important, often the 21 or 50 period moving averages work well as they are often used as a support or resistance tool. 

So I will look to see how price is interacting with the moving averages. If price has shown a pattern of respecting the moving averages and then retracing back into the zone of the moving averages, before taking off in line with the trend, then if I see my price action signal form after retracing back into the EMA’s in line with the trend, then that is a strong confluent factor, because it becomes a self-fulfilling prophecy, if millions of traders are using the standard period moving averages, they strengthen the impact of the moving averages.

The 5th most relevant confluent factor I look for is a Fibonacci retracement.

More specifically I only use one Fibonacci setting and that’s the 50% area. 

I know the 61.8 Fibonacci retracement is considered the golden number. 

However I have found that price often retraces into the 50% area of a previous significant move. 

So, if I have a price action buy or sell signal that has formed in line with the trend, and at a static or dynamic support or resistance area, I will then overlay my Fibonacci retracement tool to see if my price action signal has also formed around the 50% Fibonacci level. 

If it has, then once again, I have another factor in my favor to add weight to my decision to enter the market.

Now of course it’s a rare day when you have all 5 confluent factors present at the same time.

And indeed, if that is the case then obviously that’s gold, you are compelled to take the trade, but as I said, as long as you have the top three - Trend, Level, Signal - then you are trading with confluence and you know you have entered the market with a high probability price action set up.

So, there you have it - these are my top five confluent factors that I look for before I enter the market and I encourage you to take the time to ensure you have at least the top 3 factors present before you take your next trade. 

If you do that before you take every trade, you will find your ratio between winning and losing trades change dramatically.

I hope you have found this week’s  tactical trading tactic helpful.

I’ll see you next Friday.

Till then, keep trading and have a wonderful weekend!

Apart from these tactical trading tips, there are 2 more ways I can help you:

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