Becoming successful in the forex market requires you to have an edge that enables you to make a consistent profit. While there are different ways to put the odds in your favor when trading, confluence trading is a proven technique for achieving the best results. But first, what is confluence trading?
In a nutshell, confluence trading involves the combination of two or more trading techniques to increase your chances of winning on a trade. These techniques or factors might include a strong trend, price action buy or sell signals, key support or resistance levels, and moving averages. Now that we have defined confluence trading, let’s discuss how it can be put into practice.
Price Action Confluence Trading Techniques
Here are the top three price action confluence trading techniques:
- Resistance Level Confluence Trading
Confluence trading with resistance levels involves the intersection of two or more key resistance levels. Technically, resistance levels cannot intersect but they can overlap to some degree with other elements on a chart to aid confluence trading.
These overlaps will happen when:
- Two trend lines or channels, one ascending and the other descending cross one another.
- A trend line crosses with a resistance level,
- Multiple support and resistance levels exist in the same region on the chart.
This confluence of resistance levels or support levels in other cases, provide traders with multiple opportunities to effectively trade swings and reversals.
Trading with Confluent Support and Resistance levels
When trading with confluence, it is advisable to look out for multiple forms of support and resistance levels. One easy way to validate these levels and see how valuable they can be is to use price action.
When using price action to find key levels for confluence trading, the goal is to identify areas where trading behaviors have changed in the past and highlight the possibility for the same change to happen in the future.
There is no guarantee that this past behavior will happen again in the future but its function is mainly to identify areas or levels that will be useful for trading. When a confluence of support and resistance occurs, it provides strong buy and sell signals because these levels indicate a possible reversal of the trend especially when they have been tested by price action.
For instance, when a strong uptrend stops at a key resistance level, traders can take it as a possible sell signal before the market enters into a downtrend.
As usual, there are no guarantees that it would work that way because the market tends to be unpredictable. The trend could end up blowing through the confluence rather than reversing as expected.
- Fibonacci level Confluence trading
Fibonacci retracement levels have been used in trading for a long time and most trading platforms will have a Fibonacci tool built into the platform. Fibonacci levels usually form part of the most effective forex trading strategies available for trading.
These levels work best when used with higher time frames like a daily or weekly chart. When they are accurate, Fibonacci levels can indicate areas where there is a strong chance for the market to reverse.
So, how can it be used for confluence trading? Fibonacci confluence involves the use of multiple Fibonacci retracements, extension, and expansion levels that appear close to one another on a price chart.
Also called Fibonacci clusters, they represent a confluence where several Fibonacci ratios align to validate swing highs and lows or identify hidden areas of support and resistance. But they can be used in other ways.
Using Fibonacci Clusters
The first hurdle when using Fibonacci confluences is to decide how many ratios you are going to use. Most traders tend to favor the 38.2 and 61.8 retracement levels but the 78.6 and 50 retracement levels can be added if you wish you use more than two ratios.
Traders using the Fibonacci projection ratios for confluence trading can rely on 61%, 100%, 127%, and 162%. In addition, the most important Fibonacci extension levels when confluence trading includes 61%, 78%, 100%, 127%, and 161%.
A lesser-known Fibonacci tool that can be used for confluence trading is the Fibonacci time ratios. This works the same as other Fibonacci tools except that the levels it provides are based on time relationships rather than price action. This means that a confluence of Fibonacci time ratios represents a zone or future time level where a reversal is likely to happen. The time ratios you can use for this are 38%, 61%, 78%, 100%, and 161%.
After deciding on the number of ratios to use, you can use Fibonacci clusters in these ways:
The ratios appear in close proximity:
An important factor is that the ratios should form close to one another for better trading opportunities. For instance, where a Fibonacci retracement appears in close proximity to a Fibonacci projection, the cluster that forms, as a result, can provide confirmation of price reversals.
Where more than one Fibonacci level aligns on a chart, there is a high chance for the other levels that do not align to indicate areas that you should look out for when making trading decisions.
Additional Confirmation of price action:
Fibonacci confluence levels can be useful in finding the best entry points and locating target levels when it is time to close a trade. They can also be used as a trailing stop mechanism combined with candlestick patterns to understand the overall structure of the market.
One of the best ways to use the Fibonacci clusters is to use them as an additional confirmation of price action support and resistance levels. This will not only provide a better understanding of the market but also establish a market timing mechanism for executing trades.
If the Fibonacci cluster does not match the established price action levels, the price action will still be valid if it outperforms the Fibonacci levels.
Combine with the Elliot wave
The Elliot wave is an advanced technical analysis technique that you can master after establishing a strong foundation in the market as a beginner. However, combining it with Fibonacci clusters is one of the best methods of confluence trading.
This is because the Fibonacci ratios provide the basis for the Elliot wave principle. This means that the Elliot waves in a market cycle can be measured using specific Fibonacci ratios depending on the position of the market.
When combining the Elliot wave with Fib ratios, wait until the third wave has formed. In most cases, the third wave will be the strongest of the three and will indicate the strongest momentum of the price action.
- Confluence trading with trend lines
Trend lines are often referred to as dynamic support and resistance levels because they follow price action. Using trend lines forms an essential part of several trading strategies and is also a powerful method of confluence trading.
Traders use trend lines for confluence trading because it provides high-probability trades and increases the chances of making favorable trades. After drawing the trend line, the best technique for trading is to wait until the price hits the line and open a buy or sell position. The price action meeting the trendline serves as one of the best metrics for determining how successful the trade is going to be.
However, trendlines alone are not enough to guarantee accurate predictions and traders should look for additional confirmation by using technical indicators like the Fibonacci retracement, Bollinger Bands and moving averages. If the price hits the trend line and at the same time coincides with a Fibonacci level or 200-day moving average, for instance, this increases the odds of your trade succeeding.
If there is still uncertainty regarding the signals provided by the trend lines, traders can wait for certain candlestick patterns like the engulfing pattern and pin-bat pattern to form before opening either a buy or sell position.
Confluence trading mainly involves identifying trading opportunities and not necessarily a trade itself. Therefore, any confluence trading method you apply still requires the basic factors that go with successful trading. For confluence trading, you still need to identify your risk parameters, entry triggers, and the placement of your stop loss.
While each technique has its merits, they should not be used alone if you want to get the most accurate prediction of what the forex market is going to do next.