The Power of Confluence in the Forex Marketdailyfx.com /f orex/education/trading_tips/daily_trading_lesson/2014/05/15/The-power-of -

conf luence.html

James Stanley15 May 2014 19:05 GMT

Talking Points:

Psychological price levels can change trends and create swings within the market.

Traders can combine psychological levels with other f orms of Support and Resistance tof ind which levels may have the most potential.

Areas of conf luent support and resistance can of f er entry potential f or swings and newtrends.

In our last article,

The Hidden Levels of Support and Resistance in the Forex Market, we looked at the study of‘Psychological’ support and resistance levels.

As we shared in the article, human beings of ten think in round numbers and traders are nodif f erent. This means that stops and limits will of ten exist around these ‘rounded’ intervals on thechart, and as trends move and prices surge into these batches of waiting orders; price action canchange dramatically.

Trends can be stopped dead in their tracks… and if the batch ‘sitt ing orders’ are large enough, af ull-on reversal may be af oot.

In this article, we’re going to attempt to take this study a step f urther by helping traders to noticewhich of these levels may end up carrying more weight with f uture price action.

Support and Resistance Does Not Exist in a Vacuum

A common question that new traders pose is ‘which type of support or resistance should I bewatching or which is most important?’

The only truthf ul answer to this question is that it ’s impossible to know which support orresistance level may elicit a change in price behavior until it ’s already happened.

But traders can attempt to see which prices may carry more power by aligning multiplepermutations of support or resistance analysis, and looking f or commonalit ies.

Let’s walk through an example together.

In EURUSD earlier this morning, selling denominated the early portion of the European session.Prices dropped f rom 1.3715 to 1.3650 in the f irst f our hours of European trade.

In the f irst hour of trade, prices moved down to the S1 weekly pivot point (the red line on thechart at a price of 1.3771), and then selling slowed. It didn’t stop, as prices still moved lower; but itdid slow.

Conf luence can be powerf ul, in both the short and long-term

Created with Marketscope/Trading Station II; prepared by James Stanley

Over the next 3 hours, price action grinded lower until a price of 1.3650 was hit (a minorpsychological level highlighted by the f irst yellow circle), at which point buyers began to come in.Notice how price action oscillated between the psych level, and the S1 Pivot f or f our hours, evenattempting to move lower but reversing yet again at 3650 (second yellow circle).

Af ter the second attempt at breaking 1.3650, sellers retreated and buyers took over, as pricesthen began moving higher, eventually catching resistance at the psychological level of 1.3725(third yellow circle).

This is conf luence; and while the S1 weekly pivot point wasn’t enough to turn around prices, thecombined f orce of the S1 pivot along with a psychological support/resistance level at 1.3650certainly was. This is why traders want to use multiple f orms of support and resistanceidentif ication, because you never know which one (or which combination) will impact prices untilaf ter it ’s happened.

Why/How does conf luence work?

The bigger question to ask is why technical analysis might work?

The logic behind technical analysis is that if enough people are seeing something, and thusreacting to those stimuli, it can potentially become a self - f ulf illing prophecy.

Take the 200-day moving average

as an example. If every trader in the world were watching AUDUSD trade up to the 200-day movingaverage; and if enough traders sell under the premise that resistance may come in – that canchange the supply and demand in that market, and that can create a reversal in price (more buyingthan selling means prices will move up). In the example below, we can see how the conf luent levelof .9750 in AUDUSD promulgated a strong reversal in the trend.

Conf luence can exist between indicators and psychological levels

Created with Marketscope/Trading Station II; prepared by James Stanley

Support and resistance levels are no dif f erent. As prices approach these levels, traders observethe potential f or a reversal.

And when multiple support or resistance levels exist in the same region or area, this is called‘conf luence,’ and this conf luence of support or resistance can of f er traders multiple reasons f orprices to reverse or stall; making potential trade ideas f or swings or reversals even stronger thanthey might be otherwise.

How to Find Conf luent Levels of Support and Resistance

Just as we said in the earlier portion of this article, traders are best served by f ollowing andobserving multiple f orms of support and resistance analysis.

Price action

can be used to validate which levels have been valuable, as traders can notice swings in prices orreactions in markets to see which price levels have elicited new behaviors.

But traders can attempt to see which levels may of f er a higher chance of exhibit ing support orresistance in the f uture by applying multiple studies.

Longer-term pivot points

(weekly and monthly) will usually generate considerable interest, and the same can be said f orFibonacci retracement levels within longer-term trends.

Traders can apply these on the longer-term charts as I had in the EURUSD example, whilef ollowing the more granular psychological support and resistance levels on the longer-termcharts.

Traders can also look to indicators, as we had in the AUDUSD example with the 200-day movingaverage. Parabolic SAR, Volatility bands, or Price Channels can all be applied to the chart in thetrader ’s search f or conf luent levels of support or resistance.

How to Trade Support and Resistance Conf luence

So support and resistance conf luence can show us areas where reversals or swings may takeplace, but what’s next?

Traders should keep in mind that there is no f orm of analysis that will predict f uture pricemovements. If there were, there would be no reason f or me to write this article, or f or you to readit. Trading would be easy because we could f ollow this ‘holy grail’ all the way to the promise land.Unf ortunately, the f uture is and will remain unpredictable.

Instead, trading is about probabilit ies. And seeing an up-trend stall at resistance, or a down-trendpause during support simply shows us an area where a reversal in price may take place.

As price action signals potential reversals, traders can look at this as an opportunity f or apotential trade entry with a posit ive risk reward ratio. As in, if you’re right – you can look to make$2 f or every $1 that you’re risking in the event that you’re wrong. This is the ef f ort to avoid theTop Trading Mistake, or The Number One Mistake that Forex Traders Make.

Traders can use price action to signal entries af ter integrating Support and/or Resistance

Taken f rom The Price Action Trigger, by James Stanley

You can use this in combination with multiple t ime f rame analysis to trade retracements in ‘major ’trends on longer-term charts; or you can even include additional indicators such as I do in myshort- term momentum trading strategy.

The possibilit ies are endless; but provided traders are f ocusing on risk management and risk-ef f icient entries, there are numerous ways that support and resistance conf luence canbenef icially be integrated into a trader ’s approach.

We walked through such an approach in the article How to Catch Swings in the Forex Market.

We f urther explored the topic of using price action to trade swings in the article How to Identif yPositive Risk-Reward Ratios with Price Action.

--- Written by James Stanley

Bef ore employing any of the mentioned methods, traders should f irst test on a demo account.The demo account is f ree; f eatures live prices, and can be a phenomenal testing ground f or newstrategies and methods. Click here to sign up f or a f ree demo account through FXCM.

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15 May 2014 19:05 GMT