Engulfing pattern strategy guide (PDF)
Engulfing pattern is a type of candlestick pattern. These candlestick patterns represent an important element of price action analysis. However, candlestick shapes can offer highly likely signals about the possible result on the chart. This kind of pattern offers a useful manner for crypto traders to join the market and expect a possible reversal in the coins trend. Moreover, engulfing candles are frequently huge and have the power to drive the market quickly. two types of engulfing patterns exist. The Bullish and the bearish engulfing pattern. In this course, we will examine this type of pattern in detail and give you all the information needed about this pattern.
Engulfing patterns FAQ
What does an engulfing candle mean ?
Engulfing candlestick pattern consists of two candles (mean two periods), which is why considered a double candlestick pattern. As its name suggests, the exceeded candle engulfs the entire body of the prior candle. It can also engulf more than one prior bar. But to consider it as an engulfing candle, it should be at least one prior candle engulfed. Keep in mind that the engulfing bar has a higher high and a lower low, than the prior candle (this means that the first bar fits in the body of the second candle). Moreover, this pattern indicates the change in the market sentiments which can be a sign of a reversal in the present trend direction. For this reason, forex traders use it to detect possible reversals in the trend momentum.
As you can see in the image above the first (1) candle, which is a dark color, is always characterized by a small body, followed by a large candle, which is hollow, whose body completely engulfs the prior’s candle body. Technically, this means that the price of the second candle opens lower than the prior low (the closing price of the first candle), but the pressure of buy pushes the price up to a level higher than the prior high. And reaching an apparent win for the buyers. However, keep in mind that on crypto markets, you do not find open and close trading periods. Nonetheless, you can transfer coins 24/7. So the second candle just needs to surpass and engulf the first candle.
Types of engulfing candlestick patterns
There are 2 types of engulfing candlestick patterns. The first one is the bullish engulfing pattern and the other is the bearish engulfing pattern.
Bullish candle
The bullish engulfing pattern is a bullish reversal pattern, that occurs usually at the bottom of a downtrend, and provides the strongest signal. It begins with a bearish candle. Next, this bearish candle becomes completely engulfed by the next candle (bullish candle). However, this tells that there is high buying pressure on the market. And more buyers are entering the market and moving the price up also. Which triggers a reversal of an existing trend. This pattern allows forex traders to analyze the market sentiment and signals the start of a new bullish trend.
Bearish candle
The bearish engulfing pattern is the opposite of the bullish engulfing pattern. It represents a bearish reversal. This pattern occurs usually at the top of an uptrend and provides the strongest signal. On the graph, you find the bearish pattern begins with a bullish candle. Then, this candle gets completely engulfed by the next candle, which represents a bearish candle. Therefore, this tells that there is high selling pressure on the currency market. Also, there are more selling entering the forex or crypto market and moving the price down. This leads to a reversal of the current trend.
This chart below contains bullish and bearish engulfing bars. We can see the bullish engulfing candles, colored in Blue. Also, they are characterized by an arrow that’s going upwards. Contrarily, bearish engulfing candles are colored in purple. A downward arrow takes place on top of the bar to indicate the tendency.
How to trade with the engulfing pattern ?
- Entry Point
The entry of the trade will be confirmed by the pattern confirmation. You verify this by the third candlestick as we said earlier. Which assumed to break the second candle (engulfing candle). Therefore, when the candle closes after this level, you obtain the validation of the engulfing pattern, then you can enter this trade.
If you find yourself in a bearish scenario, then the breakout of the price should be via the bottom of the engulfing candlestick. And this represents a signal to sell the security. Otherwise, if you are in a bullish scenario, then the breakout of the price should be via the engulfing candle top. Which is a signal to buy.
- Stop-loss
When trading this pattern you have to be always aware of the risk you are getting. Therefore, you need to protect your position by putting the stop-loss. Which will protect your investment, and will help you to find the potential maximum loss. And you can analyze your risk/reward before entering any trade to help you make the right decision.
The most suitable place to put the stop-loss is beyond the extreme zone of the pattern. However, if it is a bullish pattern, you should set the SL beneath the lower candle of the engulfing candlestick. And if it is a bearish Forex pattern, you should set the SL just above the up candle of the engulfing one.
- Take-profit
The rule here is that the trade should be kept until at least the price movement is identical to the pattern size. Meaning that the Min that you should follow from this pattern should present the same distance between the ends of the upper and lower bar of the engulfing candlestick.
Once you accomplish this distance by the price movement, you have two choices, the first choice is to close the entire trade and the second is to close part of it. However, if you choose to maintain a part of the transaction open, you should observe the price movement carefully for a potential opportunity of exit. This includes S & R breakouts and channel/trend breakouts. Other important things here are chart patterns and candlestick patterns.
How to use Engulfing Candle to build a Forex strategy
Bullish engulfing strategy example
First of all, we notice that we have a high increase in prices for the first three candles. Secondly, the pattern plots four bearish engulfing candles. Theoretically, this candle pattern alerts us about a movement reversal. Which happened when prices kept falling until they hit the 1.13243 horizontal line. We should enter a long position after observing Bearish Engulfing patterns.
Bearish engulfing strategy example
What we see below is similar to the Bearish example. As a start, we observe falling prices. After that, we notice four engulfing candles. Together, they form a bullish engulfing pattern. Following this, a downtrend would take place. The signal here would be to short sell the asset after the bullish engulfing pattern.
How do you confirm Bullish and Bearish engulfing candle patterns ?
To confirm the engulfing pattern you should look at the candle that comes after the formation of the pattern (the third candle). If the latter breaks the body of the engulfing candle the pattern is valid. However, a confirmed bullish engulfing is normally accompanied by an upward candle, which breaches the engulfing candle upward. While a confirmed bearish engulfing pattern should accompanied by a bearish candle, which breaches the engulfing candle downwards.
How reliable is this candle structure ?
Chartists can trade reliable reversals near engulfing structures. However, this engulfing strategy has to confirm the pullback through price activity or other oscillating tools in order to confirm the bounce. Because engulfing candles do not permanently have to materialize at move ends. In fact, an engulfing may appear as a corrective candle if the movement is strong enough to persist. Also, subsequent price activity is so important to validate the bounce after the engulfing bar. In short, when the forex market direction is weakening and an engulfing formation appears, it is ideal to trade the bounce. That is why the forex strategy has to validate the engulfing candle before trading any pullback possibility.
Conclusion
The Engulfing candle belongs to the candlestick pattern category. It is used by forex traders to determine potential reversal trends in the currency and coins market. This pattern consists of two candles: engulfed and engulfing candles. But, there is a third candle that you should also keep an eye on, which is the third candle that comes after the engulfing candlestick and is used to confirm the engulfing pattern.