How do you know that it is safe to enter or exit a trade? Correct answer: Look for confluence!
If you enter a trade without being certain that it’s safe, you run the risk of making a losing trade.
Finding a point of confluence is a great way to avoid too much analysis, which not only will give you a headache, but also take up too much of your time.
Trading forex is only as complicated as you make it.
In this article, we’ll explain just what confluence is in forex trading and why you need to look for it in your trades.
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What does confluence mean?
Confluence is defined by the Cambridge Dictionary as:
“[A] situation in which two things join or come together.”
What does this mean for forex trading?
Well, it means looking for two (or sometimes more) signs that you have found a safe opportunity to buy or sell.
Why is it important to look for confluence when trading forex?
Because you can be sure that it is safe to buy or sell to increase your chances of success and reduce losses.
You cannot solely rely on technical analysis or fundamental analysis alone. Especially just one indicator.
These measure past movements, not current movements. Further to that, indicators are not signalling to buy or sell.
In actuality, they are measurements of how the market is moving. You rarely, if ever will get things exactly correct. The odds are heavily against you.
Finding points of confluence is an important step in becoming a consistent trader. Unfortunately, you will not make your millions on one lucky trade.
In reality, you will make your fortune through a series of well-thought-out trades.
By incorporating looking for confluence into your trading strategy, you can be more precise with your trades and be more consistent.
An excellent rule when finding points of confluence is to look for at least three reasons to make a trade and a maximum of one reason why you shouldn’t.
Ideally, though, there should be no reason why you shouldn't make the trade.
Confluence can give you confidence in your trades
Confluence can give you confidence that it is okay to make a trade. An overlooked factor, confidence plays a very important role in trading.
When we lack confidence, it can lead us to make a series of poor trades.
You stop caring if they will be successful or not you can make some big losses and you stop accessing the market properly.
That said, too much confidence can also be as equally damaging. What you need to look for is the right balance.
How can I find confluence?
You can find points of confluence in many different ways. What might work for you might not work for another trader.
To find the right method that works for you, you should try a variety of different strategies.
You may primarily use one indicator to find opportunities and the second as confirmation that it is safe to make a trade.
But don’t use too many indicators. Keep to three at the absolute maximum. Any more and you will confuse yourself.
Trend lines and support and resistance
One of the easiest ways to find a point of confluence is by combining trend lines with support and resistance.
The logic behind it is simple. If you see an emerging trend, place a trend line over it. Then place your support and resistance lines.
The places where the two intersect are your points of buying or selling. You can also use a channel pattern instead of a trend line if you prefer.
Be careful when drawing support and resistance levels, keep it to five lines at the most. Any more and you run the risk of getting confused.
What you should focus on is drawing the lines that are clearest to you. More recent areas are more important.
Another thing to take into consideration with this strategy is that trends can end. You need to be certain that the trend will continue for your trend lines to be correct.
Remember to update your support and resistance levels every time you trade.
Using indicators
A great way to find confluence is by marking support and resistance and using an indicator. A popular way to do this is by combining support and resistance with Bollinger bands.
The strategy is very simple. When a support or resistance levels meets the lower band, it is a signal to buy.
And when a support or resistance level meets the higher band, it can be a signal to sell.
Check out these 20 indicators that are used by gurus here.
Five pips rule
Some traders recommend entering or exiting the trade where you see confluence up to five pips below or above the area.
There are two reasons why this can be useful.
Firstly, it allows you some wiggle room. You have to remember that these points of confluence are not a guaranteed science, they are areas that have a high probability of success.
These extra pips can act as further confirmation that it is okay to make a trade.
For example, you want to enter the market, and you have found a possible area of confluence, however, you are not sure if the market will go lower or higher.
Ideally, you want it to go higher because it is confirming that a trend will follow, so you place an order five pips above.
If it reaches this point, you will not only be in the market but have a trend acting in your favour which will make it easier for you to exit the market.
This also works the other way as well when exiting the market. Again, you have found a point of confluence, but you’re not sure what direction the market will head.
To play it safe, you place a stop-loss five pips below the point of confluence.
Maximise profits
Of course, you may not maximise your profit, but you will be able to lock up what you earned instead of risking it for more.
In a sense, using the five pips rule is further point of confluence, just without the aid of indicators.
The second reason you may use the five pip rule is the opposite to the above. You may want to play it risky and make as much as possible.
For example, you have found a point of confluence and are looking to enter the market. You may buy five pips below if you want to get the lowest possible price.
The risk here is that there may not be an upwards movement that follows.
Then, when you have found the second point of confluence to exit the market, you may risk it again by placing a take-profit order five pips above. If this risk pays off, it can be beneficial.
Problems with confluence forex trading
The key problem with confluence trading is that you may start trying to use too many signals to buy or sell.
As we have mentioned, this can cause a situation where you don’t know what you should be doing.
Some signals may be telling you to buy while others are telling you not to.
This, in turn, can lead to the dreaded analysis paralysis which is where you are so overwhelmed with conflicting data that you don’t know what to do so you don’t do anything.
You then end up simply watching the market moving, missing plenty of valuable opportunities because you simply can’t spot them through all your indicators.
But there is a way to counter this; use only a couple of indicators. An important thing to remember is that simpler trading strategies work best.
If your trading strategy has many components, more things can go wrong and mess up your trades.
Further to that, simpler trading strategies are easier to repeat. You don’t need to think about them that much which also makes them less stressful too.
A great way to simplify your confluence trading strategy is by relying on one indicator to find opportunities and the second indicator to act as confirmation that it is safe to trade.
Look at the overall trend
If the market is on an uptrend, is there really a need to sell when you could sell at a much higher price?
The same goes for buying. Is there a point in buying when the market is going lower and lower?
Not all points of confluence are worth trading.
Set yourself appropriate goals
Traders shouldn’t just believe that points of confluence alone is good enough. They still need to have in place acceptable goals; they should know when to enter and exit the market.
In a sense, this can act as another layer of confluence.
Risk management should always be considered. Just because you have found a point of confluence, do not simply think that you have found a good place to trade.
You need to think about your risk-reward ratio. If where you enter and exit are too close together, is the trade worth making?
Further to that, you should also believe that when you enter a trend that it will continue to climb. If it doesn’t, you may end up making a loss.
So, as you can see, confluence is not always as straightforward as it looks.
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Key points
If you remember anything from this article, make it these key points.
- Confluence is defined as when two (or more) signals are giving you the same sign. This allows you to enter or exit the market with more confidence.
- Using trend lines and support and resistance levels is a great way to find confluence. Indicators are also useful to incorporate but don’t use too many.
- Consider using the five pips rule. Enter or exit the market five pips below or above the point of confluence.
- Not all points of confluence are worth trading. Traders should look at the overall trend before buying or selling.
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