The Power of Confluence in the Forex Market
What is confluence and why is it so important when trading the Forex market? In this article I’m going to discuss what confluence is, why it’s so important and how you can integrate it into your current trading strategy to help put the odds in your favor.
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, 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, a 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.
Putting the Odds in Your Favor
I think I can be so bold as to say that consistent profits is the goal of every serious Forex trader. So why then do only a small portion of traders make it to this level? It all comes down to the use of confluence. Those traders who can be called consistently profitable have found a way to identify and harness the power of confluence in a way that puts the odds in their favor.
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.
Putting the Power of Confluence to Work
This is my favorite part because it’s where we get to highlight the power of confluence as it relates to a particular trade setup.
To start, let’s say we have a strong uptrend in a given market. We all know that trading with the trend, or path of least resistance, is always a good idea. At the risk of sounding cliché, the old saying, “the trend is your friend” is absolutely true in my experience.
So Confluence Factor #1 becomes a strong uptrend.
The second thing we notice is a key support level that has just come into play. The market has retraced from a recent high and now appears to be finding support at this level.
Confluence Factor #2 = Key support level.
With respect to the key support level, price action has now formed a bullish pin bar from this level. Pin bars can be a great indicator that the market has reached a swing high or low and is about to reverse.
Confluence Factor #3 = Bullish pin bar.
Last but not least we notice that the tail of this bullish pin bar intersects with our 10 and 20 exponential moving averages that we use as part of our trading strategy. So it appears our moving averages are also providing dynamic support in combination with the key support level.
Confluence Factor #4 = Dynamic support from moving averages.
You get the idea. The list could go on and on and the factors you identify will vary depending on your style of trading. However the point to take away from all of this is that the more Confluence Factors we have on any given setup, the better the odds are that the setup will move in the intended direction.
This works both ways, however. Just as a trade setup with more factors can be thought of as higher quality, a setup with fewer factors is of lesser quality. This is when patience is so important – to have the ability to wait for the trade setup which has four or five factors instead of taking the setup that has just two or three factors.
It’s important to keep in mind that although confluence helps to put the odds in your favor, it doesn't mean a setup with four or five factors can’t fail. Instead you want to focus on the bigger picture. You know that if you patiently wait for those “A+” setups that your account will begin to grow over the following weeks, months and years. Becoming a profitable Forex trader is a marathon, not a sprint.
Just as a casino doesn't expect to win every hand, you shouldn't expect to win every trade no matter how many Confluence Factors are present. Having said that, the casino knows that by the end of the year it will have made a sizable profit because the odds are stacked in their favor. So start thinking like the casino and begin using confluence to stack the odds in your favor.