In Forex, especially while studying technical analysis, you may hear the term confluence used in conjunction with trade setups. What is confluence and why should you care about it as a Forex trader?
Confluence refers to any circumstance where you see multiple trade signals lining up on your charts and telling you to take a trade. Usually these are technical indicators, though sometimes they may be price patterns. It all depends on what you use to plan your trades. A lot of traders fill their charts with dozens of indicators for this reason. They want to find confluence — but oftentimes the result is conflicting signals. This can cause a lapse of confidence and a great deal of confusion. Some traders add more and more signals the less confident they get, and continue to make the problem worse for themselves.
Most Forex traders who succeed do so with a minimal number of indicators on their charts. Two or three is a good number of indicators to aim for. Some traders use just one, and some use none at all — though it is harder to find a good trade context if you do not have any at all.
Here is a good example of using confluence to place a great Forex trade. Say you trade using price patterns formed by the candlesticks on your chart, and you see a pattern which signals a "buy" trade. While the price pattern itself might be all you need to be right 80% of the time, perhaps you have discovered that confirming the pattern with some confluence can help you to be right 90% of the time. Maybe you have tested and discovered that Fibonacci retracement levels can help you find a good context. If your price pattern, which signals "buy", lines up with a Fibonacci retracement level, which is acting as a support, then that is a great example of an "A" trade confirmed by confluence (the price action and the Fibonacci level). Note how this is not a cluttered Forex system. Aside from the Fibonacci levels, there are no indicators drawn on the charts at all. All you are looking at here are price patterns. You only overlay the indicator when you want to check the context surrounding a price pattern. If you notice that the retracement level matches up with a pivot point you have been keeping an eye on, that is another form of confluence.
This is only one example of using confluence in Forex. There are many different ways to use confluence. Systems are as varied as personalities. Test different combinations of signals to determine the best Forex indicators for you to use. Experiment and see what gives you the best statistical results over a large number of trades using historical data. Maybe you will find that using confluence of moving average crossovers combined with Fibonacci levels gives you great results. Maybe you will discover that Bollinger bands used in conjunction with support and resistance tests well. One thing, which is important to note, is that when you experiment with confluence, you need to choose indicators that are independent of each other — not calculated using each other. Otherwise, you will stack up time lag, which will only decrease accuracy.
Confluence is beneficial because it does more than show you a good setup in isolation — it shows you a good setup in context of the market. This is essential in Forex to avoid fakeouts, unexpected reversals, and trading against the trend. In a way, most Forex systems are built on the idea of confluence. If you have not found a system you like, this is how you can start building one from scratch. A good system will show you what is going on right now, and how it fits into the bigger picture — and how you can profit from that knowledge.