Engulfing Candlestick Pattern

What is the Engulfing pattern?

Traders make use of the engulfing pattern to enter the market while hoping for a possible trend reversal. Candles in this pattern signal a reversal in the current trend. It involves two candlesticks with one candle entirely “engulfing” the body of the other. To get a valid engulfing pattern, the first candle has to fit inside the body of the next candle.

The engulfing candle can either be bearish or bullish, depending on its location in the current trend. The opposite scenario is possible too. Since it is formed by two candles, it is categorized as a double candlestick pattern.

A candlestick shows the open-to-close range of every trading period. Its timeframe can vary from a second to a day or more – depending on the settings of the chart. Viewing two bars next to each other will offer a good comparison of the market direction from one time to the next. The color of the candle indicates if the direction of the price has gone up (green or white) or down (red or black).

How to identify the Engulfing candlestick pattern?

For a perfect engulfing candlestick, no part of the first candle can exceed the shadow (or wick) of the second candle. This entails that the low and high of the second candle entirely covers the first. But the major emphasis is on the body of the candle.

Engulfing candles are one of the most used candlesticks to determine if the market is experiencing downward or upward pressure. However, it is necessary to have it in mind that engulfing candles are lagging technical indicators – meaning they come up after price action – as they need the data of the worth of the two previous candlesticks before they give a signal.

There are 2 types of Engulfing patterns

There are two types of engulfing candlestick patterns: bullish and bearish engulfing candlestick patterns.

Bullish engulfing pattern

The bullish candle gives the best signal when it appears below a downtrend and shows a rise in buying pressure. The pattern mostly causes a reversal of a current trend. It’s due to more buyers entering the market and driving prices further up. The pattern involves two candles, with the second green candle completely engulfing the previous red candle with no regard to the length of the tail shadows.

This pattern is a two-candle reversal pattern that is a combination of one dark candle followed by a larger hollow candle. On the second day of the pattern, prices are lower than the previous low, yet buying pressure pushes the price to go to a higher level than the previous high, causing an obvious win for buyers. Traders are advised to enter a long position as the price goes higher than the high of the second engulfing candle.

Price action has to show a clear downtrend when the bullish pattern appears. The big candle indicates that there are a lot of buyers in the market and this gives the previous bias for more upward movement. Traders will then look for confirmation that the trend is turning around by using indicators. They can be important resistance and support levels, and subsequent price action after the engulfing pattern.

Bearish engulfing pattern

A bearish engulfing chart pattern is a technical pattern that indicates lower prices to come. It consists of a high (green) candle followed by a large down (red) candle that engulfs the smaller up candle. The pattern is necessary because it signals that sellers have overtaken the buyers. These sellers are aggressively driving the price downwards, more than buyers can push up.

This pattern is simply the opposite of a bullish pattern. It offers the best signal when seen above an uptrend and shows a rise in selling pressure. The candle mostly causes a trend reversal, as more sellers are going into the market to drive prices further down. The pattern is made up of two candles with the second candle completely engulfing the previous green candle.

When the bearish pattern appears, price action has to clearly show an uptrend. The big bearish candle means that sellers are aggressively going into the market. This gives the previous bias for more downward momentum. Traders will then look for confirmation that the trend is reversing.

What does Engulfing patterns tell traders?

Bullish pattern

The bullish candlestick tells traders that buyers are in total control of the market, following a previous bearish run. It is often seen as a signal to buy and take advantage of the market reversal. The bullish pattern is also a sign for traders having a short position to think about closing that trade.

Even though the wicks of engulfing candles are not as necessary as the bodies, the second candle in a bullish engulfing can give a perfect indication of the location to place a stop-loss for a long position. This is because it shows the lowest price a trader is willing to accept in exchange for an asset at that point. Therefore, if the present uptrend reverses, you will see a clear exit point for your position.

Bearish pattern

A bearish pattern indicates that the market will soon enter a downtrend, following a past increase in prices. The pattern signals that the market has been taken over by bears and could push the prices even further down. It is often seen as a sign to enter a short position in the market.

Also, the pattern shows that those in a long position should consider closing their trade.

Although the wicks are not usually considered important to the pattern, they can give traders an idea of where to put a stop-loss. For a bearish engulfing pattern, you should place a stop-loss above the wick of the red candle. Since this is the highest price the buyers were willing to pay before the downturn of the asset.

How to trade when you see the Engulfing candlestick pattern?

Isolate the trend

The first step in trading the engulfing candle is to note the direction of the strongest trend. It’s the direction you will trade-in.

An uptrend is indicated by higher-swinging highs and higher-swinging lows in price. You should take only long positions during an uptrend, buying to sell later when the price rises.

A downtrend is indicated by lower-swinging lows and lower-swinging highs in price. Take only short positions when there’s a downtrend, selling a borrowed asset to buy and return it later when the price goes down.

Watch for upward or downward pullback

After you’ve established the trend, wait for a pullback. If you don’t notice any trend, or if the trend is not clear, don’t use this strategy.

Entering the trade after the engulfing candlestick pattern

When you’ve isolated the trend and notice a pullback occurring, enter the trade. After initiating the trade by making use of the engulfing candle strategy, put a stop-loss above the current high for short positions, and lower than the current low for long positions.

Exiting the trade

A rule of thumb is to ensure your winners are as big as your losers; two times bigger is best. Measure the distance between your entry point and where you placed the stop loss.

Exit the trade if the trend tries to reverse by making a higher high and higher low during a downtrend and short trade or by making a lower high and lower low during an uptrend and long trade.