In this blog post, we will delve into a crucial yet often overlooked topic in trading : trading with confluence.
Mastering this concept can make a significant difference in your trading account.
By using confluence wisely, you can avoid low probability trades that often lead to losses. Instead, your trading decisions will be based on solid reasoning, setting you apart as a successful trader.
what exactly is trading with confluence?
Trading with confluence entails leveraging various market signals to make informed trading decisions.
Rather than relying solely on a single candlestick pattern, chart pattern, or indicator signal, confluence trading considers multiple factors.
To illustrate this concept, let's examine the example of a double top chart pattern.
How To Trade A Double Top Chart Pattern With Confluence ?
As a price action trader, you should have a basic understanding of double tops and double bottoms.
If you're unfamiliar with these patterns, I highly recommend reading my detailed blog post on the subject.
A double top pattern indicates a potential trend reversal. It occurs when the market fails to break above a resistance level on two consecutive attempts, signaling a shift in control from buyers to potential sellers.
Take a look at the chart below:
In the chart, you can see that the market was in an uptrend with strong buying pressure. Buyers were in control. However, their failure to break the resistance level raises the possibility of a momentum shift. Yet, this observation alone is not enough.
There's always a chance that buyers might make a third attempt and break the resistance level.
To confirm the double top formation, we need additional factors of confluence.
Refer to the chart below:
In this chart, you can observe that the neckline of the double top pattern was broken. The neckline serves as a support level, and the fact that buyers couldn't break the resistance while sellers pushed the market below the support level solidifies the confirmation of a double top formation.
This breakdown suggests a potential trend reversal. However, before making a trading decision to buy the market, let's consider more factors of confluence.
How To Use The Relative Strength Index As A factor Of Confluence ?
Let's analyze the RSI indicator to gain further insights into the market.
Take a look at the chart below:
As depicted in the chart, the RSI broke below the 50 level, indicating a downtrend. This further aligns with our analysis and strengthens our confluence.
Now we have three factors of confluence supporting a sell order:
Firstly, the double top pattern signifies buyers' failure to sustain the upward momentum.
Secondly, the neckline breakout confirms sellers' intention to reverse the market downward.
Lastly, the RSI indicator points to a downtrend.
To execute this trade, place an entry order at the close of the candle that confirms the breakout, and set your stop loss just above it.
For added safety, you can place the stop loss around 10 pips above the breakout candle.
Set your target profit at the next support level. That's all there is to it, and with a bit of luck, the market will move in your favor. Look at the chart below :
How To Trade Head And Shoulders Chart Pattern With Confluence ?
Now, let's explore another example that highlights the importance of confluence in your trading. Take a look at the chart below:
In this chart, you can see that the market was in an upward trend, forming a well-defined head and shoulders pattern.
If you're not familiar with the head and shoulders pattern, don't worry—I have a comprehensive blog post covering it in detail, which you can check out below:
The head and shoulders pattern is a reliable indicator of a trend reversal. When this pattern forms on a chart, it suggests that buyers have failed to sustain the upward momentum, signaling a potential reversal.
However, relying solely on this information is not enough. We need additional factors of confluence to strengthen our confidence in this trade setup.
The first factor of confluence we can consider is the breakout of the trend line. Refer to the chart below:
As depicted in the chart, the market formed a clear trend line, which was eventually broken, indicating a potential trend reversal.
Notably, if you observe the breakout closely, you'll notice that it was strong, suggesting the presence of significant selling pressure behind this move.
The second factor of confluence is the breakout of the support level, often referred to as the neckline.
This breakout signifies that sellers have gained the upper hand, increasing the likelihood of the market moving downward.
Is this sufficient to enter the market? Yes, it is. However, let's look for additional factors of confluence to further enhance our confidence.
Let's use the RSI indicator to identify more confluence factors.
Take a look at the chart below:
In this chart, you can observe a clear divergence between price and the RSI. While the price was ascending, the RSI was descending.
This divergence serves as another confluence factor that supports our trading decision.
Additionally, the breakout of the 50 RSI level confirms that we are already in a downtrend, further bolstering our case for entering this trade.
Considering all these factors, we now have several reasons to support our decision to enter the market.
To execute this trade, simply place an entry order at the candle that broke below the neckline, and set your stop loss just above it. As for the target, aim for the next support level. Look at the chart below :
Using Fibonacci Retracement Levels as a Factor Of Confluence
Let's explore the final example, which vividly illustrates how trading with confluence can significantly enhance your trading performance.
Take a close look at the chart example below:
In this chart, you'll notice a strong upward trend characterized by higher highs and higher lows.
As a price action trader, it is crucial to recognize this robust uptrend and focus on trading in the direction of the trend, rather than seeking reversals. Our aim is to join this upward momentum and capitalize on potential profits.
To effectively trade an uptrend, it is essential to understand the pattern it follows. Allow me to provide you with a brief explanation.
An uptrend typically consists of two significant moves : an impulsive move that aligns with the trend, and a retracement move that temporarily goes against the trend.
As a trader, your objective is to identify the beginning of the impulsive move in order to align with the prevailing uptrend and avoid getting caught in retracement moves.
Refer to the chart below:
Within this chart, you can clearly observe the impulsive moves followed by retracement moves.
These alternating phases are characteristic of an uptrend. When a retracement move occurs, it breaks through the previous resistance level, which then transforms into a support level.
This support level becomes an important point as it signifies the potential starting point of the next impulsive move.
To position ourselves to join the upcoming impulsive move, we must patiently wait for the price to reach the support level. Observe the chart below:
As demonstrated in the chart, once the price reaches the support level, a distinct pin bar formation emerges, indicating a strong rejection and signaling the initiation of another impulsive move.
At this stage, we possess several confluence factors : an established uptrend, a significant support level, and a candlestick pattern signal.
These elements alone provide a solid foundation for entering a trade. However, we can further bolster our confidence by incorporating additional confluence factors.
Let's consider the Fibonacci retracement as an additional layer of confluence.
Examine the chart below:
By using the Fibonacci retracement tool, we can observe that the pin bar was not only rejected from the support level but also from the 61.8% and 50% Fibonacci retracement areas.
These levels hold substantial importance and are closely monitored by successful traders.
The presence of this confluence factor serves to confirm our trading decision. With all these factors in place, we are now well-positioned to enter the market with confidence. Refer to the chart below:
As depicted in the chart, we execute our entry at the close of the pin bar, while placing our stop loss 10 pips below the wick.
As for the profit target, we aim for the next significant level. Following these steps, the market mysteriously aligns in our favor, presenting profitable opportunities.
By embracing the power of confluence, you significantly heighten the likelihood of successful trades.
This approach empowers you to identify high-quality trading opportunities while instilling unwavering confidence in your decision-making process.
By incorporating the concept of confluence into your trading strategy, you elevate your potential for remarkable trading outcomes.