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Right through this guide, we will have a detailed discussion about what engulfing candlestick is and how you can trade with it. Of course, we all know that the candlestick pattern is important to analyse the price action in any stock market.
Engulfing candlestick pattern is categorised into two forms, i.e., bearish and bullish. These are the easiest candlestick reversal patterns for identification.
Just because these candlestick patterns are known to be two-candlestick patterns, they are more valid and looked upon as reversal patterns.
To trade with engulfing candlestick patterns, it is important to first start with the scanning of charts from daily, weekly and monthly. Later on, you can move to the lower time frames.
What is the engulfing pattern all about?
The traders generally use the Engulfing pattern to step inside the market and hope to avail a sudden trend reversal. Therefore, candles of this pattern will signal a reversal in the current trend.
This pattern involves two candlesticks with just one candle completely “engulfing” the body of another one. To acquire an excellent engulfing pattern, it is important to let the first candle get fitted into the body of the next candle.
Engulfing candles can be bullish and bearish based on the current trend location. The opposite scenario is equally possible. It is formed through two candles. Therefore, it is also known as the double candlestick pattern.
How can you identify the engulfing pattern?
To have an excellent candlestick pattern, no part of the first candle can exceed the wick or shadow of the second candle. In this way, the high and low of the second candle will completely cover the first candle!
Engulfing candles are among a few of those common candlesticks with which a trader can determine if the market is under upward or downward pressure.
We want to mention that engulfing candles lag the technical indicators. They will only come up after the price action. This is because they need all the data of two previous candlesticks before giving any signal.
Why are engulfing candles important for the traders?
Engulfing candle pattern helps traders find reversal, identifies a strengthening trend and helps traders have an exit signal:
- Reversal: Reversals are taken for granted – they allow the trader to enter the trade at the highest possible level and manage the trend until it is completed.
- Continuing the trend: Traders can look at the stunning pattern to support the continuation of the current trend; for example, when they see a bull pattern during an upward trend, they are more confident that the trend will continue.
- Exit Strategy: The pattern can also be used as a signal to end an existing trade if the trader has a position in an existing trend that is coming to an end.
A limiting candle can appear if the formula turns out to be a reversal rather than a definitive change of direction. Still, traders can look for another price action to reduce the chance of this side effect.
What are the two main types of engulfing patterns?
Engulfing candlestick patterns are divided into two main types, including bearish and bullish candlesticks. Let’s discuss them one by one in detail below:
1. Bullish engulfing pattern
The bullish candle gives the best signal when it appears under a declining trend and increases the buying pressure.
The pattern often causes the current trend to change. This is just because the majority of the buyers are entering the market, which increases the prices. This trading pattern is a wonderful combination of two different candle patterns. The larger hollow candle follows the black candle.
On the 2nd day of the pattern, you will find the prices to be a bit lower than the previous low. Thus, the buying pressure will push the price higher than its previous high. This will result in an obvious win for the buyers.
Traders should enter the long position once the price starts moving high in comparison to the price 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, which gives the previous bias for more upward movement.
Traders will then look for confirmation that the trend is turning around using indicators. It can be a significant level of resistance and support and a series of price actions against the swallowing pattern.
2. Bearish engulfing pattern
The bearish engulfing pattern is a technical pattern that indicates that a low price is approaching. It consists of a tall (green) candle followed by a big candle down (red) that consumes a smaller candle.
A pattern is necessary because it signals that sellers are catching up with buyers. These sellers are aggressively pushing prices down more than buyers.
This pattern is the opposite of the bullish pattern. Nevertheless, it offers the best signal, as seen on the surface of the constant increase in sales pressure.
Candles often cause a change in fashion because many retailers go to the market to raise prices. The pattern is based on two candles in which the second candle is fully consuming the previous set of the green candle.
If a bearish pattern is seen, the price action should show an upward trend. A big bear candle means that traders are entering the market aggressively. This causes a further decrease in the previous distortion. Traders will then look for confirmation that the trend is returning.
What does it tell the traders?
1. Bullish pattern
Under the bullish candlestick pattern, traders can see that buyers have full market control following the bearish run. It even signals to buy and take full advantage of market reversal.
In addition, a bullish pattern also signals the traders having a short position where they can consider closing the trade. Nevertheless, the wicks of the engulfing candles are not as necessary as the bodies.
The second candle is bullish; engulfing will indicate the traders to figure out the place where they can locate stop-loss for a long position. This is because it shows the lowest price which a trader is willing to accept in place of any asset at that specific point.
2. Bearish pattern
A bearish pattern indicates that the market will soon enter a downtrend. This is following through the past increase in the prices.
It even signals that the stock market is now completely taken over by the bears and can push the prices even more down. Thus, it even gives the sign of entering a market in a short position.
The pattern even shows that those in the long position should consider closing the trade.
In a bearish pattern, wicks give the traders an idea about where they should place the stop-loss. It can be placed just above the wick of a red candle. This is undoubtedly the highest price that the buyers are willing to pay just before the actual downturn of their assets.
How can you trade with Engulfing candlestick patterns?
To successful trade with engulfing candlestick pattern, you need to follow the below-mentioned steps:
1. Isolating the trend
When trading with the engulfing candlestick, you need to note down the direction of the strongest trend. This is the direction in which you will start trading.
An uptrend is generally indicated by the higher-swinging highs and the higher-swinging lows in a stock price. During the uptrend, you should take the long positions. You aim to buy and sell it later once the price rises.
The downtrend indicates the lower-swinging lows and the lower-swinging highs in a stock price. During the downtrend, you should take the short positions. Then, you can sell the borrowed asset to buy and, later on, return it once the price falls.
2. Keep an eye on upward or downward pullback.
Once you have successfully established the trend, you must wait for the pullback. Avoid using this strategy if you did not notice any trend or in case the trend is not properly clear.
3. Enter the trade after engulfing the candlestick pattern
You can enter the trade once the trend has been isolated and you did notice the occurrence of pullback.
Once the trade has been initiated through engulfing candle strategy, you can put a stop-loss just above the current high for the short positions. It needs to be lower than the current lower for the long positions.
4. Exit the trade
The golden rule is that you have to ensure that your winners are big enough like your losers. It has to be two times bigger. Carefully measure the accurate distance between the entry point and where you locate the stop loss.
You can exit the trade once the trend has reversed by making higher highs and lows during the downtrend.
What are the pros and cons of engulfing candle patterns?
- These patterns are identifiable visually
- Both bearish and bullish patterns can occur on different forex pairs and time frames.
- These patterns are highly profitable to trade the forex reversals.
- It can produce false bullish and bearish reversal signals.
- On the larger time frames, the stop losses can be extensive
- It might even precede the choppy market conditions or consolidation
Limitations and importance of engulfing candlestick pattern
The importance of engulfing candlestick patterns in trading is high. As traders, we take full advantage of new trends when the market starts to change direction.
Changing patterns, bullish and bearish, herald future changes in price direction as the dominant force loses momentum, causing another force to earn.
Both the patterns occur at the ending point of a strong trend. The idea behind the strong absorbing pattern announces that the second candle has enough energy to start a new trend.
Thus, the bottom of the second candle is a bit lower than the bottom of the first candle. This shows that the bullish pattern can push through the price action from session lower to the higher prices. You might not have seen it in the previous first session.
However, like other candlestick patterns, the recesses have their limitations. Although they are very strong at the end of a strong trend, they are hardly sold when seen in the wrong business.
Thanks to the easy viewing of the bullish candlestick pattern, it is a popular choice among traders. In addition, the bullish formula offers traders an attractive risk-reward ratio when they use it to enter crypto trades.
We recommend linking the pattern to other technical analysis and technical support tools to get the most out of pattern trading.
For example, a market that corrects horizontal support, trend line support, or a simple moving average followed by a bullish pattern is a strong signal that the trend may continue.
Related questions (FAQs)
1. What is meant by engulfing candles?
The term bullish engulfing pattern is a white candlestick! It closes itself higher in comparison to the opening of the previous day after opening itself lower than the previous day’s close.
2. Can you take an engulfing candle, both bullish and bearish?
Yes, it can be both bearish and bullish based on where it has been formed with the ongoing trend. A bullish candle will signal the reversal of the downtrend and indicate a certain rise in buying the pressure.
3. How can you use engulfing candlesticks?
You need to wait until the candle engulfs with the down candle in any engulfing candle strategy that signals the uptrend. Then, once the candle moves above a certain opening price, you can enter a long trade.
4. Are engulfing candles profitable
A bullish engulfing candle will provide the strongest signal once it appears at a downtrend’s bottom. After that, the candles indicate a certain surge in the buying pressure. Finally, it even drives the prices to move further.
To end the discussion, it is clear that engulfing the candlestick strategy is all about isolating the trend. Traders can use the engulfing pattern to signal that the pullback is about to end and the trend is finally resuming.
But note that every pullback does not end with the engulfing pattern. Sometimes, it will require multiple bars to signal the end of the pullback. You don’t have to wait for the engulfing candle to get completed.
Jason Morgan is an experienced forex analyst and writer with a deep understanding of the financial markets. With over 13+ years of industry experience, he has honed his skills in analyzing and forecasting currency movements, providing valuable insights to traders and investors.
Forex Content Writer | Market Analyst