Trading Confluence of Chart Patterns

October 27, 2017 12:16 PM
Applying classic chart patterns to current trading opportunities

Chart patterns form purely as a result of knowledge-based bias work in the markets. The learned behavior of traders to buy and sell above and below the key support and resistance levels or around critical price levels (highs, lows, pivots) creates price barriers in the form of trendlines or channels.

These barriers become action/reaction lines and form geometric structures — chart patterns. Successful pattern trading requires the knowledge of chart pattern formation, its arrangement and its market manipulation. The recognition of patterns and their body of knowledge and knowing how to react and what to expect with certain patterns can help a trader’s success.

What is Confluence?
Technical analysis is the study of behavioral patterns of various technical events. Confluence is when there is more than one technical analysis concept coming together at the same point in the market. Traders find a setup that has multiple price concepts from various non-correlated techniques or multiple price-patterns that have found a high probability trading opportunity and there is a high chance of the trade working out successfully. Finding a confluence could eliminate noise when it comes to a validating signal. When multiple ideas or events begin to unfold, traders look for confluence to have an edge before entering a trade.

Confluence can be found in all forms of the markets: Price patterns, moving averages, pivots, support or resistance levels, trendlines and Fibonacci levels. When some or all of these tools meet at a single location to form a unified event, it is considered a point of confluence. Confluence trading is simply combining more than one trading technique or chart pattern or analysis to increase trader odds of winning on a trade.

This is significant. As any technical trader knows: Trendlines are broken, not every pattern holds true, support and resistance is broken and moving average crossovers do not always signal a profitable trade. The more technical tools that validate a move, or simply confirm the significance of a price, level the stronger that level is.

Patterns Confluence with Price Levels
Here we will present a basic example of how the confluence concept works with patterns and price levels.  

The confluence of various price levels forming support and resistance zones makes that support and resistance stronger. Confluence zones from multiple pattern or trade setups act as key areas for price-action. Trading solely with these price levels may not be the best choice, but using these confluence zones with pattern setups may result in profitable trades. Here, we show how these confluence price zones can be anticipated and how to create ABC chart pattern entries.

“Floor & Fibonacci pivots” (below) shows an S&P E-mini daily chart with an ABC bullish pattern and floor and Fibonacci zone pivots indicators. The E-mini S&P 500 formed an ABC Bullish pattern from July to November of 2016 with a long entry at 2088 and a stop at 2068. The first target zone is 2198 to 2233 and the second target zone is 2335 to 2408. A floor and Fibonacci zones pivots (monthly) indicator is also plotted on the same chart to find potential support and resistance zones. A confluence target zone for ABC bullish pattern targets and pivots target zones is formed from 2365 to 2394. ES reached its confluence target zone 2388 in March 2017.

Patterns Confluence 
The confluence of technical indicators or patterns is a great way to validate trends and enter trades with confidence. When similar chart patterns (continuous or reversal) form in multiple timeframes at the same point, it indicates higher probability trading opportunities. Here are examples in the iShares 20+ Year Treasury Bond ETF (TLT) in multiple timeframes and various chart patterns to show the significance of confluence trading. 

A double-bottom pattern is formed in TLT on a weekly timeframe from June 2015 to April 2017 with a long entry at $119 and stop at $116 (see “TLT weekly,” above). The first target range is $134 to $139. Also, notice an embedded Dragon bullish pattern inside double bottom pattern in January 2017.

“TLT daily” (above) shows a TLT daily chart along with our proprietary trend indicator eSIX. The trend indicator eSIX uses non-correlated components to derive the underlying trend. TLT made lower-low swing prices from January 2017 to April 2017, whereas eSIX indicator made higher-highs, which signaled positive divergence and a potential reversal in its downtrend. From April to mid-May, TLT also formed an ABC Bullish pattern. The confluence of TLT’s double-bottom pattern (weekly) and the ABC bullish pattern with a strong positive divergence signaled a long trade opportunity. The ABC trade entry was at $121.25 with a stop below $119.90 and targets are $125 and $130.

“TLT 5-wave” (above) shows a daily TLT chart with a confluence of a five-wave bullish pattern along with the weekly double bottom bullish pattern and the ABC bullish patterns. A bullish divergence from the bottom of the price and a five-wave pattern show a higher-high and a higher-low swings. Five-wave patterns are similar to Elliott Wave patterns with simple wave formations. A bullish price channel is drawn on the five-wave pattern to compute the target zones. The five-wave pattern target zone is set at the top of the trend-channel at $132 to $134.

About the Author

Suri Duddella