What is Confirmation
Confirmation refers to 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 often feels 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.
BREAKING DOWN Confirmation
Confirmation can also refer to a broker's written acknowledgment that they have completed a trade. These can be in electronic or paper form, and record information such as the date, price, commission, fees and settlement terms of the trade. Brokers typically send a confirmation within one week of the trade's completion.
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 are 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 (ATR). Volume indicators include the Chaikin Oscillator (also used to measure momentum), on-balance volume (OBV) and the volume rate of change. (To learn more, see: How do Traders Identify Confirmation of Prices on a Chart?)
Suppose a trader notices a golden cross, which occurs when the 50-day moving average, crosses above the 200-day moving average. This is a signal to buy the stock, based on a trend indicator (the moving averages). Because this signal alone does not guarantee higher prices, 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 volumes might make the trader reconsider taking a position in the stock. The OBV indicator would, therefore, be a logical choice to confirm the trade: 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.
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 always send conflicting messages to some extent, but traders should take care not to discount mixed signals.