Candlesticks are pictorial representations of price action for a given time period on a stock’s price chart. They contain price movement that tells us the opening, close, high, and low prices of a financial asset. When a combination of candles exists, it paints a picture or provides a trading strategy for some traders to enter and exit trades. These engulfing candlestick patterns can be a form of technical analysis and allow us to read the atmosphere of the market for a set stock.
Candlestick formations are relied on by all kinds of market participants trading various instruments. Whether you’re trading stocks, their options, forex, crypto, bonds, futures, etc., the engulfing pattern is recognized to be strategic. There are many candlestick patterns that traders use for confirmation of price movement, market reversals, and/or trend continuations. The engulfing candlestick pattern is one commonly used by traders seeking to spot a possible trend reversal. What this means in terms of market sentiment is that the opposition has entered the market with a larger force, driving the candle to move sharply against the current price action.
What is an Engulfing Candlestick Pattern?
Simply put, an engulfing candlestick pattern is a two candlestick pattern where one candlestick surrounds or covers the previous candlestick. Visually, the pattern is easy to identify.
Think of the game Pac-Man. The goal was for the yellow character to “eat” all the large flashing dots, called power pellets while moving all different directions inside an enclosed maze and not running into ghosts. Like Pac-Man, an engulfing candlestick wins out: the second engulfing candle “eats up” the first candle.
Engulfing candlesticks appear near the tops and bottoms of a price chart and depict the beginning of bullish and bearish intent; new upward movement or downward movement. When the pattern appears, it can signal where future price direction may be headed.
Some traders use engulfing candle patterns as a strategy to identify a trend reversal. Based on the engulfing pattern, they can decide to take a trade once they see further confirmation. Confirmation may be additional candles forming directionally, another technical indicator, or retesting of zones.
Bullish Engulfing Pattern
When a bullish engulfing pattern appears, you will see a red candlestick engulfed by a green candle after downward momentum signaling possible price movement to the upside. The engulfing green candle “contains” the previous red candle.
The bullish green candle gives the best signal when it appears below a downtrend and shows a rise in buying pressure. The market view being told is that the buyers have overwhelmed the sellers and the price will likely reverse with upward momentum possibly pausing or ending the previous bearish run.
When the bullish engulfing pattern occurs, an options trader may buy a call or look to sell off their put if they have an open position.
Bearish Engulfing Pattern
When bearish engulfing candlestick patterns appear, you will see a green candlestick engulfed by a red candle after upward momentum signaling possible price movement to the downside. The engulfing red candle “contains” the previous green candle.
The bearish red candle gives the best signal when it appears above an uptrend and shows a rise in selling pressure. The market view being told is that the sellers have overwhelmed the buyers and the price will likely reverse with downward momentum possibly pausing or ending the previous bullish run.
When the bearish engulfing pattern occurs, an options trader may buy a put or sell off their call if they have an open position.
Important to Note
Whether a bullish pattern or bearish pattern, it is important to note that the body, the open and close, of the new candle must contain the body, open and close, of the previous candle completely engulfing it.
If the engulfing candle’s high and low covers the previous candle’s high and low, meaning the wicks as well, the pattern is found to be more valid.
Also, take into consideration where you see the engulfing candlestick pattern form on the price chart, in what time frame, and acknowledge the overall existing trend before contemplating a trade. Visually seeing this pattern may not be enough evidence that a trade exists.
The pattern may not identify a market reversal but possibly just a temporary correction. This is a limitation of the engulfing pattern. The pattern can be more of a retracement than a definitive change in direction, but traders can look for additional candles to follow and their price action to reduce the likelihood of taking a loss.
Trading involves significant risk so take the time to practice identifying candlestick patterns and introducing them to your trading strategies. Get comfortable with the asset you desire to trade and see what patterns tend to work best with the strategy and/or technical indicators you have chosen to use and on what time frames they are most reliable.
Summary of Engulfing Candlestick Pattern
Bullish and bearish engulfing candles are one of the most used and effective candlestick patterns to determine if the market is experiencing downward or upward pressure. They are a form of technical analysis that can demonstrate the end of a bullish trend or bearish trend and give clues to a possible forthcoming pause in price direction or an actual market reversal.
A trader needs to keep in mind that engulfing candlestick patterns are lagging technical indicators. This means they form and tell their story after the price action has occurred and another candle count down has started.
Profitable traders may not use the engulfing pattern alone to enter a trade. Most recognize the engulfing candlestick pattern, realize its limitations, and use it with other strategies or technical indicators. It is always best to await further confirmation that the trend reversal has taken place before entering a trade to increase your odds of profitability.
A great strategy to consider using with engulfing candlestick patterns is supply and demand which you can learn from the Maurice Kenny Day Trading Program.
Resources to Check Out
Article on this website: Top Indicators for Day Trading
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