How to use confluence zones when we trade: finding a good price level
This blog post deals with concept of confluence in trading i.e. when different levels or signals come together in agreement to provide a strong indication of what price is going to do.
What is Confluence?
con•flu•ence (ˈkɒn flu əns)
- a flowing together of two or more streams, rivers, etc.
- their place of junction.
- a body of water formed by confluence.
- a coming together of people or things; concourse.
- a crowd or throng; assemblage.
Definition credits: Random House Kernerman Webster's College Dictionary, © 2010 K Dictionaries Ltd. Copyright 2005, 1997, 1991 by Random House, Inc. All rights reserved.
When traders read a price chart in order to trade, i.e. applying technical analysis, there is one place on the chart that they like to look for: a confluence zone.
Confluence zone is a region where multiple levels or signals occur near to or overlap each other
A confluence zone can be made up of some of the following items:
- Historical support & resistance levels
- Monthly, weekly or daily highs and lows
- Fibonacci ratios
- Extended trendlines
- Top or bottom bands of equidistant channels
- Chart patterns
- Signals from trading indicators
The more signals or levels appear in a confluence zone, the greater its significance. For example, a confluence of resistance levels makes the whole resistance zone stronger than if there was one level only. Similarly a trader can expect a higher probability trade from a confluence of trade signals that agree with each other than if there was one signal only. Like the Chinese proverb describing strength in unity, "it is easy to break a chopstick, but they become unbreakable when we put all of them together".
Illustration - Confluence zone of resistances on silver chart
Looking at this monthly chart of silver (XAGUSD), we can piece together the reason price came down was because it could not penetrate a confluence zone of three resistance levels:
Make use of confluence zones to power your trading
Confluence zones are good because of consensus
Confluence zones are good because multiple signals in one region offer consensus to traders. Person A using Technique 1 sees a signal. Person B using Technique 2 sees another signal. Person C sees a third signal using Technique 3. If those signals they see come together in a confluence, all three persons agree with each other although they might be working independently. Good confluence zones are therefore significant because a big number of traders who might be working independently arrive at the same conclusion. When they act in concert at the same region, there is a lot of strength be it a resistance or support or a trade signal.
Place trades around confluence zones
Because confluence zones are strong and significant, they form good turning points or points where price will pause to consolidate. This makes confluence zones good levels to enter and exit trades. To have higher probability trades, do the following:
- Place entry trades on one side of a confluence zone and place stop loss levels on the other side. The strength of the zone makes it less likely the trade will be stopped out.
- Set target price inside confluence zones because these are the best levels where price will pause or reverse.
Tips to find confluence zones
As mentioned earlier, confluence zones are formed when multiple levels or signals occur near to overlap each other. Unfortunately there is no short cut to find a confluence, the only way is diligently draw your trendlines, horizontal support resistance levels and so on. Follow these principles:
- Horizontal support resistance levels are more consistent and easier to find than trendlines or extend trendlines.
- The higher the time frame of chart used, the more significant the levels or signals are
- The more times a level or trendline has been tested, the more significant it is
- Chart patterns offer very nice symmetries that contribute to confluence zones: start by identifying chart patterns then look for confluence based on chart pattern rules.