Confluence occurs when several technical analysis methods give the same trade signal. Usually, these are technical indicators, but may also be combined with chart patterns, price action, and chart overlay tools.
Originally, the term confluence is used to describe a geographic point where two or more rivers come together to form a single body of water.
But following the same logic, it’s now used in the context of trading, to describe the confluence of multiple trading signals.
In the chart below, you have a confluence of indicators creating a strong resistance area consisting of:
- A descending trendline
- 200 SMA acting as a dynamic resistance level
- 61.8% Fibonacci retracement level
- RSI showing an “oversold” reading
Other examples of confluence could be:
- RSI signaling oversold and the price is trading near a support level.
- A trendline coming together at the bottom of the Bollinger Band.
- Price trading near its 200 SMA, the 50% Fibonacci retracement level meeting, and a major support level.
In a nutshell, the concept of confluence can be summarized as:
“An area in the market where two or more structures come together to form a high-probability buy/sell zone.’
The confluence of trade signals could lead to greater accuracy and profitability.
“Confluence trading” is when you combine more than one trading technique or analysis to increase your odds of a winning trade.
You use multiple trading indicators that all give the same “reading”, as a way to confirm the validity of a potential buy or sell signal.
Confluence refers to any circumstance where you see multiple trade signals lining up on your charts and telling you to take a trade.
For example, if you use a single technical analysis tool that has a 40% accuracy rate of predicting the price movement, and then use a second on-correlated technical analysis tool to filter your decision further, then you increase your odds of winning.
In other words, you use the concept of “confluence” to find a trade setup using multiple technical analysis methods, and all of these independent forms of analysis signal a similar directional price movement.
For instance, this happens when support and resistance levels are closely in line with Fibonacci retracement and extension levels.
Psychological levels, previous highs and lows, and dynamic support and resistance levels (such as moving averages or Bollinger Bands) can also act as areas of interest.
When these levels coincide, they form stronger support or resistance levels, which could be used as entry points or take profit levels.