Engulfing Candlestick Pattern

Engulfing Pattern Definition, Engulfing-Candlestick Pattern meaning. What Is “Engulfing Candlestick Pattern” in Forex? 

 

The engulfing candlestick patterns, bullish or bearish are one of the easiest of candlestick reversal patterns to identify. Because these candlestick patterns are two-candlestick patterns, they are more valid and are often looked upon as reversal patterns. As with any candlestick pattern, the bullish or bearish engulfing pattern takes more priority depending on the time frame that they are formed on. Therefore, when looking to trade with the engulfing candlestick pattern, it is essential to first scan the charts from monthly, weekly and daily and then to the lower time frames.

What are engulfing candlestick patterns?

 

Engulfing candlestick patterns takes two candlesticks to be identified. A bullish engulfing pattern is characterized by a bullish candle whose body, the open and close engulfs the previous candle’s body. Conversely, a bearish engulfing pattern is characterized by a bearish candle whose body engulfs the previous candle’s body.

Figure 1: Ideal Engulfing Patterns

For more validity, if the engulfing candle’s high and low engulfs the previous candle’s high and low, the pattern is found to be more valid. The chart below shows different examples of various bullish and bearish engulfing candlestick patterns. In the example chart below, we also point out a false or an invalid engulfing pattern. It is false due to the fact that the open and close (the body) of the second candle does not completely engulf the open/close of the previous candle.

 

Figure 2: Bullish and Bearish Engulfing Patterns

Why are engulfing candlestick patterns formed?

 

An engulfing candlestick patterns are usually identified near the tops and bottom. They exhibit extreme market sentiment. In other words, a bullish engulfing pattern tells us that the buyers have overwhelmed the sellers in the market, thus engulfing the entire previous day’s open and closing prices. Conversely, a bearish engulfing candlestick pattern tells us of the sellers overwhelming the buyers and thus indicative of a drop in prices.

Engulfing candlestick patterns can be traded as a reversal candlestick pattern when found at the tops or bottom of a short term trend and validated by support or resistance levels. When an engulfing candle is formed within a trend, they are to be traded as a continuation pattern.

How to trade engulfing candlestick patterns?

 

The first step is in identifying the engulfing pattern within the context of the previous trend, of course not to forget the main prevailing sentiment or the major trend.

In figure 3, we identify a bullish engulfing candlestick pattern that was formed right near the bottom of a short term down trend. We notice that right after the bullish engulfing candlestick pattern, it was followed by a strong Pin bar and subsequently prices started to push higher. In the same chart, we can also notice how the down trend started by a bearish engulfing candle formed right at the top.

As can be seen from the examples in this chart along, the engulfing candlestick patterns are strong patterns and when validated by other methods can offer great insights into taking positions based off these candlestick patterns.

 

Figure 3: Bullish Engulfing Candlestick pattern

Another great way to trade the engulfing patterns is to scroll down to a lower time frame to fine tune the entry. For example, if you spot a bullish engulfing pattern on a daily chart, then scale into a H4 or H1 charts to pick out entries with lower risk and high probability.

In Figure 4, we identify a bearish engulfing pattern formed on the weekly charts. While most articles will tell you to place a sell order near the engulfing low with stops at the engulfing high, it is a rather crude way to trade. For example, the chart below shows how the bearish engulfing candle was formed. But notice a candle later the high that was made was higher than the high of the engulfing candle

 

Figure 4: Bearish Engulfing on Weekly Charts

This shows us yet again that when placing stops for trading engulfing candlestick patterns, due caution must be taken. Because it is well known that traders would attempt to place their stops just above the high of the engulfing candle, price can very easily push higher to stop out the traders before moving in the original direction.

To conclude, the engulfing candlestick patterns are two candlestick patterns and when formed near the tops or bottoms can indicate a short term change in sentiment. Depending on the price action, price could either start a new trend in the opposite direction or merely head towards making a correction to the previous trend.

As with any candlestick price action trading, engulfing candlestick patterns must be looked upon within the larger context of the markets and not in isolation.

 

High Probability Forex Engulfing Candle Trading Strategy:

The engulfing candle trading strategy is one of my favorites. It’s easy to spot and provides a way to enter a trend. Many traders use the engulfing candle to signal the end of a trend, but here we are going to use it to enter a trend at an opportune time. Using the trend and the engulfing candle as a trade trigger provide a powerful combination.

Candle stick charts have become a staple for most traders, and nearly every trading platform offers this highly visual chart style. Whether it is better than other chart forms I leave up to you. It isn’t necessary to use candle sticks to trade the strategy, OHLC charts also work.

I use this strategy for day trading, although it can be applied to other time frames as well, and to various markets such as the stock market.

Forex Engulfing Candles

There are two types of engulfing candles, a bullish engulfing candle and a bearish engulfing candle.

A bullish engulfing candle occurs when the “fat” part of an Up candle completely envelopes a prior Down candle. The fat part of the candle marks the distance between the open and close of that bar, while the “wicks” mark the high and low. While there is no specific size requirement, typically both bars in the pattern should be substantial, with the up bar showing a strong short-term shift in momentum.

Figure 1 shows an example of a bullish engulfing pattern in the AUDUSD.

On my charts, up candles are green–the close is higher than the open. Down candles are red–the close of the candle is lower than the open of the candle.

Figure 1. Bullish Engulfing Pattern: AUDUSD 1-Hour Chart

Get a current short, medium and long-term analysis of the AUDUSD free…instantly:  AUDUSD Trend Analysis

A bearish engulfing candle occurs when the “fat” part of a Down candle completely envelopes a prior Up candle. Figure 2 shows an example of a bearish engulfing pattern in the EURUSD.

Figure 2. Bearish Engulfing Pattern: EURUSD 5-Minute Chart

If you look back at figure 1 you’ll notice that right before the bullish engulfing candle pattern, there was a bearish engulfing pattern as well. Engulfing candles occur quite often, which is why we need to some sort of other filter to trade them. I opt to use the trend.

Forex Engulfing Candle Trading Strategy

Engulfing candles occur often. While its appearance signifies a sharp short-term change in direction, many of these patterns aren’t of concern. In a trend there impulse waves and corrective waves. Ideally we want to enter on corrective waves, or pullbacks, and then “ride” the impulse for a profit.

The engulfing candle provides us a signal that a pullback is over, and the trend is about to resume. In the case of an uptrend, the bullish engulfing pattern signals that the selling which occurs on a pullback is over, and the buying is resuming. The trend doesn’t always resume right away, we may simply get a small push in the trending direction before the pullback resumes. Losing trades occur, and that is OK, as all losing trades can’t be avoided. Experienced traders can actively manage trades when this occurs, making a small profit or small loss. Alternatively, simply let the price hit your stop or target (discussed shortly) and let the odds of the trade, and having a larger potential profit than risk, work in your favor.

Figure 3. Bullish Engulfing Candle Trading Strategy in Uptrend

Get a current short, medium and long-term analysis of the EURUSD free…instantly: 

For a bullish engulfing candle in an uptrend, the stop-loss is placed just below the low of the engulfing candle.

In the case of a downtrend, the bearish engulfing pattern signals the buying which occurs on a pullback is over, and the selling is resuming.

Figure 4. Bullish Engulfing Candle Trading Strategy in Downtrend

For a bearish engulfing candle in a downtrend , the stop-loss is placed just above the high of the engulfing candle.

Engulfing candles are simply an entry technique, and therefore don’t provide a profit target. Profit targets can be established using Fibonacci Extensions. Apply the Fibonacci extension tool to the impulse wave and the pullback to get an indication of where the price will go on the next impulse wave.

Alternatively, use a 1.6:1 or 2:1 reward to risk ratio. For example if you risk is 10 pips, your profit target is 16 or 20 pips respectively.

To help filter which trade signals you take, and isolate the trend, you wish to employ other indicators, such as trendlines or a moving average.

Forex Engulfing Candle Trading Strategy Entry Point

The traditional method is to let candles complete before entering. That means once the the engulfing candle finishes and a new one begins we enter the trade. Yet price bars are arbitrary. There is no relevance to the close of a 1, 5 or 15-minute candle. Therefore, we are watching for these signals in real-time, and as soon as we see an engulfing pattern with the proper setup we trade it, without letting the bar complete.

In the stock market the daily open and close aren’t arbitrary, they are set and have impact. Therefore, stock traders may opt to let daily bars complete. Intra-day bar timed bars are still arbitrary.

Figure 5 shows how this works in a downtrend.

Figure 5. Forex Engulfing Candle Trading Strategy Entry Point

There are a number of reasons for doing this. Mainly, a timed price bar is arbitrary (if there are questions on this, I will respond to it in the comments section).

Also, it helps to reduce risk. Engulfing candles show a powerful change in direction. If we wait for a bar to complete it may have already run significantly, which means our stop is bigger and our profit potential is diminished.

Finally, we’re trading with the trend, so probability is already on our side. Getting in before a bar closes doesn’t change our odds of success.

It is possible that when we look back at our trades, an engulfing pattern may not be present. By entering early we allow for possibility that by the time the bar closes it is no longer a traditional pattern. Yet in real-time it exhibited the shift in momentum we were looking for, and that is all that matters.

The engulfing signal doesn’t necessarily have to come from one bar either. Assume we have a downtrend, and a pullback moving higher. Then a down (red) bar comes, but it isn’t quite an engulfing candle. A few seconds after another down (red) starts taking out the lows of prior up (green) candles. To me this is a still a valid entry. Even though it was over a number of candles, it still shows the change direction. Once again, traders need to rid themselves of the notion that there is something magic about the close of a bar, especially in forex day trading.

Forex Engulfing Candle Trading Strategy – Final Word

The goal of the strategy is to isolate a trend, and then use engulfing patterns to signal the pullback is ending and the trend is resuming. Not every pullback ends with an engulfing pattern though, sometimes we can use multiple bars to signal the end of a pullback (see video mentioned above).There is no need to wait for the engulfing candle to complete. Once it has engulfed the prior candle, take the trade. Engulfing patterns don’t have a specific profit target, therefore using a Fibonacci extensions or a fixed reward to risk ratio. Stops are placed above the high of a bearish engulfing pattern, or below the low of a bullish engulfing pattern.