Sunday, January 15, 2012

Advanced Trading Topic: Confluence

-Confluence in Trading-
Real World Definition: 1. A coming or flowing together, meeting, or gathering at one point. 2. In geography, a confluence is the meeting of two or more bodies of water.

Synonyms: convergence, conjunction, convergency, meeting
Antonyms: divergence

When 2 streams come together and flow together there can be a spectacular current that is dependent on the force of the 2 streams. In nature the flow of water is a very powerful force - much like a strong trend in trading.

In Trading, my definition of confluence is when 2+ forces intersect and more accurately the implementation of multiple trading strategies into one. When there are more forces intersecting there is more confluence. When several forces intersect at once we more astute traders will say there is a great deal of confluence. One might say well that's just a fancy word for "confirmation" - not exactly but there are similarities. I see confluence as something that occurs more naturally than when a trader is looking for some type of confirmation of a signal in their linear trading system.

It takes greater knowledge to spot confluence than a simple confirmation - the greater degree of understanding in technical analysis and trading the greater mastery you will have of conflowing factors that work together like a strong rushing river or mark the end of a drying stream.

Confluence may also be thought of as events - as in the confluence of events. These events make up a theme.

examples of confluence in trading:
example 1 (case: reversal - bear signal) price hits a major resistance in HR4 time-frame. Soon after in the hourly tf MACD negative divergence occurs. You also see at the M15 tf that stochastic is overbought.
*All the indicators do not have to have the same signal for every time-frame.

example 2 (case: reentry or confirm short) after a strong sell off you measure from your swing high to swing low and find that price action retraces to an area of supply
that intersects with a 50% Fibonacci level. In this case the strategy is to hold a short longer (if already short) or to look for a short at the 50% fib extension retrace. *Or perhaps your not in a trade but were considering a long and you see price approaching the 50% fib at an area of supply - you might want to steer clear of that long.

example 3 (case: continuation) An Elliot C wave forms at a 38.2 retracement fibo level ie b to c for the fib extension. After the 38.2 price action of the trading instrument in question breaks through the swing point with heavy volume indicating a stronger move should follow. An aggressive trader in this scenario might place a trade at the 38.2% fib with a stop loss at the 50% fib. If the swing point (at the Elliott b wave) breaks with heavy volume it is just an indication to perhaps hold trade for more profit or trade that break. (warning aggressive strategies can produce high losses - always adhere to a stop loss in any scenario). A "conservative" trader would wait for the break of the b wave + confirmation of heavy volume in this scenario and put stop loss and the 38.2%. *note that 61.8% retracements are warning signs of a potential trend changes.



Summery
Confluence is the increase of probabilities. It's like adding more straws to the camels back and eventually the camels back will surely break - this is the case of a trend reversal.

In a continuation it is like the construction of a house - where you see the contractor putting in the foundation, then the frame, and ultimately the roof.

It becomes evident at some point that the final stages will proceed or the beginning stages will fail. You wouldn't want to place a trade against the trend when the "frame" of the pattern goes up unless there's really bad news like the builder didn't pay his bills and the project was canceled or held off do to funding - this is the equivalent of a big news event that can reverse or stall a pattern.

By Neal Vanderstelt
Forex Trader, Market Analyst, Trading System Designer

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