Confluence is defined as a situation in which two things come together or happen at the same time or a coming or flowing together, meeting, or gathering at one point. In trading, confluence is multiple trading schools of thought meeting at a price and all being in agreement that price should react, as a buy or sell, in that area.
We will break confluence into 2 categories: Trader Confluence and Additional Confluence. We MUST have Trader Confluence when we trade and we want to have Additional Confluence as well.
Trader Confluence
In the example below, we can easily see an area of trader confluence where multiple schools of trading would be interested in buying.
- Break and Retest traders have identified a level of resistance that has been broken and are waiting for that level to be retested as support in order to buy.
- Trend Line traders have a trend line drawn by connecting 2 prior swing highs and are waiting for a 3rd touch and bounce from the trend line to indicate a time to buy.
- Fibonacci traders see that price has made an impulse and is now retracing to the 50% - 61.8% levels which for them is a prime retracement level to enter a trade.
These 3 types of traders are focused on the same point of price at roughly the same time which makes this buy trade have a high probability of success since so many traders would be buying here for their own reasons. Each of these traders has 2 trader confluences from the other traders supporting their trade decision. All of which pushes price up and would make an ideal place to buy. This is the market having a consensus that this is the place to buy.
You don’t want to be alone in your trade idea especially in the face of multiple contrary trader confluences against your trade setup. If the price action shows that there would be multiple types of traders looking to buy at a given price, you don’t want to be a seller at that same price. You’re chances of being profitable increase when you trade where there is supporting trader confluence.
Before entering a trade, strive to have at a minimum 2 trader confluences supporting your trade. Including your own school of thought having at least 3 trader confluences should be the goal for every trade that you enter.
Other trader confluences come from chart pattern traders, candlestick traders, moving average crossover traders, harmonic traders, Elliott wave traders, supply and demand traders, and support and resistance traders.
Additional Confluence
Consider additional confluences as bonuses or the cherry on top. These are not necessarily required, but make your trade setup stronger if they are present. Additional confluences should not be a replacement for the minimum 2 trader confluences that you should have to enter a trade.
Common Additional Confluences:
- Divergence
- Dollar index correlation
- Commitment of Traders (COT) reports
- Stochastic or RSI overbought/oversold conditions
Confluence Is Not Confirmation
The terms Confluence and Confirmation are often wrongly used interchangeably. Confluence is multiple trading schools of thought meeting at a price and all being in agreement. Confluence can be considered the agreed upon theory that supports the probability of an occurrence. Confirmation is proof of an occurrence and can be considered the proof that the theory (confluence) is valid or invalid. Confluence is the theory that a breakout will occur or that a retracement will lead to a continuation. Confirmation is proof that a breakout is not a fakeout or that a retracement is not a reversal.
Confirmation by its nature is neutral. You can have confirmation that proves your analysis accurate or confirmation proves your analysis inaccurate. Multiple schools of trading can meet at a price, be in agreement, and can be simultaneously wrong, which is why confirmation gives proof of an occurrence independent of confluence.
Many traders lose by entering a trade based solely on confluence without having the patience to wait for confirmation. Would you show up to a hotel, without a reservation, hundreds of miles away from home based on the theory that rooms are probably available? The first thing the hotel would ask for is confirmation of your reservation as proof. You wouldn’t travel without confirmation of your flight, hotel, car rental, etc., so why would anyone trade without confirmation…let that one simmer for a while.