Confirmation

What is 'Confirmation'

Confirmation is the use of an additional indicator or indicators to substantiate a trend suggested by one indicator. Since technical indicators are not perfect predictors of future price movements, a trader will often feel more secure deciding to act on a signal if more than one indicator is sending the same signal. If different indicators send conflicting signals, this is known as divergence.

Confirmation can also refer to a broker's written acknowledgment that a trade has been completed. These can be in electronic or paper form, and record information such as the date, price, commission, fees and settlement terms of the trade. They are normally sent within one week of the trade's completion.

BREAKING DOWN 'Confirmation'

Technical indicators fall into four broad categories: trend, momentum, volatility and volume. When seeking confirmation for a trade signal provided by one indicator, it is usually best to look to an indicator from a different category. Otherwise, the same or similar inputs will be counted multiple times, giving the illusion of confirmation when in fact little new information has been taken into account. Trend indicators include moving averages, moving average convergence divergence (MACD) and the parabolic SAR. Momentum indicators include the stochastic oscillator, the commodity channel index (CCI) and the relative strength index (RSI). Volatility indicators include Bollinger Bands, standard deviation and average true range. Volume indicators include the Chaikin Oscillator (also used to measure momentum), on-balance volume (OBV) and the volume rate of change

For example, say a trader who notices a golden cross, which occurs when a short-term trend line, such as a 20-day moving average, crosses a longer-term trend line, such as a 50-day moving average, to the upside. This is a signal to buy the stock, based on trend indicators (the moving averages). Because this signal is not guaranteed to translate into a price rise going forward, the trader might seek confirmation from a different type of indicator. In this case, a high trading volume would reinforce the buy signal, while lower trade volumes might call it into question. The trader could check the OBV: a rising OBV would confirm the golden cross' bullish signal, while a flat or falling OBV would suggest that the price is nearing a top.

Confirmation Bias

When seeking confirmation for a signal, investors should always be wary of confirmation bias, the tendency to set greater store by information that agrees with preconceived notions and to discard information that clashes with those notions. Of course, different sources of information will always send conflicting messages to some extent, but traders should take care not to discount divergent signals.