One concept you may sometimes hear about when you are learning how to trade forex is confluence. You might hear someone saying you should look for confluence when identifying setups. But what is confluence and why is it important?
This post will answer both of these questions. We will also offer you a simple example of how confluence works, as well as some precautions so you do not misapply the concept.
What is Confluence?
When we say that a forex trade setup has “confluence,” we simply mean that more than one indicator, pattern, or tool is telling us the same thing.
If a single indicator is telling you to trade, and there is no confirmation from anything else, you do not have confluence.
If two or more indicators are telling you to take a particular trade, you do have confluence.
If an indicator is telling you to take a particular trade, and so is a support/resistance line, that is confluence too.
Another example would be if an indicator and a price action pattern both say to take a trade. That is also an example of confluence.
Fundamental analysis can be used as confluence alongside price action or a technical indicator as well.
Why Look for Confluence When You Trade?
No single method for spotting forex trade setups is 100% reliable. No matter how effective any particular indicator, price pattern, or fundamental analysis method is, there are times when it is not going to give you accurate information.
That is why relying exclusively on one indicator is generally not sufficient for planning your trades.
But when you have confirmation for a trade setup in the form of confluence, that is a stronger trade setup.
Now you have two or more relatively reliable indicators in agreement.
That does not mean that two or more indicators put together cannot also all be incorrect. That does happen. But it is less likely.
An Example of How to Use Confluence When Trading
Here is a simple example of a forex setup that is confirmed by confluence.
In this chart, EUR/USD has been dropping. You will notice the Williams Percent Range dips below -80, which suggests oversold conditions. It rises briefly above the -80 line a couple of times, then drops back down again. Price continues to fall as it does that.
The next time it rises above the -80 line, however, we also see a pinbar form with a downward-pointing “nose.”
The pinbar is a buy signal, and so is the subsequent rise of the Williams Percent Range line above -80. So, there are two different signals for you to buy. That is confluence.
Indeed, if you did buy at that point, you would have caught a nice move upward.
Do you see how waiting for the confluence from the pinbar in this situation would have spared you from a couple of false buy signals generated by the Williams Percent Range indicator?
A trader who was not looking for confluence might have been stopped out earlier, gotten discouraged, and then missed the big bullish move altogether.
But by waiting for confluence, you avoided those potential losses, and came out profitable at the end.
How Do You Know What Indicators to Use for Confluence?
The example we have just gone over above with the Williams Percent Range and the pinbar is pretty arbitrary.
You could build a trading method around the Williams Percent Range indicator and price patterns like pinbars, but you could also use entirely different indicators to search for confluence and identify entries.
If you have been experimenting with different trading strategies, you have probably already found some indicators and patterns you like using.
Try mixing and matching them and using backtesting to check whether they work well together to establish confluence.
If you have no idea of where to start, there are certain indicators and tools that traders tend to like to combine for confluence.
For instance, a lot of people who trade price action like to use Fibonacci retracement levels to establish confluence.
They also like to simply draw lines of support and resistance on their charts and use those to help them confirm setups (i.e. a pinbar that is located at a line of support or resistance has confluence, unlike one that isn’t at a support or resistance zone).
Caution: Do Not Go Overboard
There is one major mistake you can make when looking for confluence, and that is to go too far with it.
When you are searching for confluence, you only need 2-3 indicators to align and give you the same signal. You do not need 4, 5, 6 or more.
Novice traders often add a ton of indicators to their charts, figuring if they can just get confluence from a huge number of them, they will have some kind of perfect, foolproof system.
Alas, there is no such thing as a foolproof system. Instead, there are a number of problems that result from taking this approach to searching for confluence:
- The charts end up so cluttered with trading tools and indicators that they are hard to read.
- Traders end up with contradictory signals, and then find themselves frozen and unsure what to do.
- Some traders may find themselves waiting forever to take a trade, because they want a level of confluence that seldom if ever appears.
So, do not overcomplicate things with too many indicators. Just pick 2-3 things that work well for you, and keep your charts relatively clean.
Looking for confluence can be a big help when you are trading forex. It can help you avoid false signals and whipsaws, and can increase the reliability of your trading method.
Practice looking for confluence, and experiment with different combinations of indicators until you find a system that works well for you.
Once you have backtested and demo-tested a trading strategy successfully, you will be ready to start taking live forex trades with confluence and confidence.
Once you are confident with your trading method, you can look for a no-deposit bonus to kick-start your forex trading.