Technical traders and analysts apply various methods to identify the best possible ways to trade successfully. One of the most important methods is to look for patterns as these patterns repeat and can be identified and understood easily. The patterns can be classified mainly as chart patterns and candle patterns. While chart patterns focus on the structure of the whole chart or a particular chart area, candle patterns focus on an individual candlestick to identify a pattern.
Chart patterns and candle patterns can be further classified into Bullish patterns and bearish patterns. The patterns which imply that the prices are either currently Bullish or are reversing from a Bear trend and entering a Bull trend are called BULLISH patterns. Oppositely, patterns that signal a downtrend are called BEARISH patterns.
- What Is An Engulfing Candle Pattern
- Types for Forex engulfing candle pattern
- Bullish engulfing candle pattern
- Bearish engulfing candle pattern
- How To Enter And Exit Using The Bullish Engulfing Candle Pattern
- How To Trade The Bearish Engulfing Candle Pattern
- Difference between Bullish and Bearish Engulfing Candle
- Reversal Pattern
- Limitations of the Engulfing candle
What Is An Engulfing Candle Pattern
An engulfing candle pattern is formed by two consecutive candles; the important characteristic of an engulfing pattern is that the second candle should completely engulf the first candle.
The second candle must engulf the body of the first candle; however, the wicks may be ignored. The engulfing candles signal the end of the current trend and the beginning of a new trend, or the reversal of the prices. This essential information is the key to every Forex technical trader and the key for any successful trading strategy. The end of the current trend signal will assist the trader to exit the position completely or move the stop loss to a much favorable position or at least go for a partial exit. Similarly, the early reversal signal or the beginning of the new trend assists the trader to calculate the entry and exits and device a trading plan with defined risk and reward.
Types for Forex engulfing candle pattern
Based on the location of the candles and the trend on which they are based, they can be further classified as a Bullish engulfing pattern or Bearish engulfing pattern. Bullish engulfing patterns which form at the bottom of a downtrend have a high probability of success. Similarly, the Bearish engulfing patterns observed at the top of an uptrend provide a high rate of success.
These patterns assist Forex technical traders to prepare the best possible trading strategy. Candle patterns can provide a complete trading strategy with entry points, stop loss and take profit to Forex traders. The patterns can be measured and based on the measurements the exits can be prepared with regard to the trading strategy. Traders prefer to trade the patterns as they provide the ability to have a trading plan with definite risk and reward in advance, before executing the trade. These features of the pattern make them attractive to Forex traders.
Bullish engulfing candle pattern
The above image shows the Bullish engulfing candle pattern. In the image, the price is initially in a downtrend. However, the next Bull candle completely engulfs the body of the previous bear candle. The High, Low, Open, Close of the engulfing Bull candle is higher than the previous candle. The intention of the market is clearly visible in this price action, with the Buyers completely taking over the sellers. This action of the Buyers needs to be further validated by the next candle. The candle subsequent to the engulfing candle moves higher, validating that the Buyers are indeed taking control of the prices.
To validate further the subsequent candle should close higher than the engulfing candle, as this shows the Bears are indeed losing the ground and the reversal has taken place. Forex traders should note that the essential components of this pattern are the bear candle, the engulfing candle, and the subsequent price action. In the absence of the price action after the engulfing candle, traders should avoid trading the pattern and wait for additional confirmation using other forms of technical analysis.
Also read: Gartley Pattern
Bearish engulfing candle pattern
The above image shows the bearish engulfing candle pattern. The image shows the price in an uptrend and then the bear candle eclipse and engulfs the previous bull candle. The result can be observed in the Open, High, Low, and Close of the engulfing candle. It is essential the candle completely engulfs the body of the bear candle; however, the wicks or shadows can be ignored.
The validation of this pattern is also essential like every chart pattern or candle pattern. The price action during the candle subsequent to the engulfing candle is essential to validate the market sentiment. The initial Bear candle once engulfed shows the shift in market sentiment from Bullish to Bearish. Every technical analyst will agree on the importance of validation of a technical element before applying them to a trading strategy. So, the price action next to the engulfing candle provides further information on the market direction. The next candle moved lower beyond the low of the engulfing candle and confirms the market sentiment is indeed in favor of the Bears. It is highly recommended that traders should follow complete discipline in the validation of the trend using price action, otherwise the results could be detrimental.
How To Enter And Exit Using The Bullish Engulfing Candle Pattern
The Bullish engulfing candle is easy and straightforward to scan and spot in a chart. However, the aim is to trade them successfully and profitably. Once the pattern is spotted on a chart the next essential thing is to prepare a trading plan if the pattern is validated. By preparing the trade plan in advance the trader anticipates the possible outcome of the trade in the potential trade direction. So once the pattern is validated the trade can be placed accordingly.
The above chart shows a bullish engulfing candlestick pattern. The trader can make the entry decision once the price moves beyond the High of the engulfing candle. However, it’s recommended by technical experts to wait for the candle to close with a HIGH above the engulfing candle’s HIGH. So the trade shall be placed on the subsequent candle closes. Additionally, traders can wait for the price to retrace or enter during a pullback.
The best stop loss is below the previous swing low because the price failed to fall below and the swing low acts as a support. The take profit on the other hand is obtained by measuring the entire distance of the pattern, which is from the low of the engulfing candle to the high of the subsequent candle. The length is the anticipated take profit target level.
Also read: Elliott Wave
How To Trade The Bearish Engulfing Candle Pattern
The above chart shows the Bearish engulfing candlestick pattern, this pattern shows that price successfully reversed after the pattern. The trade is similarly opposed to the Bullish pattern and can be traded effortlessly.
In the above chart, the price was in an uptrend followed by a bearish candle that engulfed the previous candle. As soon as the trend is scanned and spotted in the chart, the trader can prepare the trade plan. The best spot for a stop loss is the previous high since the price was unable to break that level as it acts as a resistance. The take profit is calculated the standard method of measuring the total length of the pattern, that is the distance from the High of the engulfing candle till the low of the subsequent candle.
Alternately, the take profit can be trailed using the trailing stop loss to ride the trend or the take profit can be carefully adjusted. Using another trend following technical indicators or as per the requirements of the technical trading strategy.
There is much software available in the market and many traders are coding new software to scan the pattern automatically. The software can automatically scan the chart and alert the trader instantly once the pattern is spotted the software. Additionally, the software can recommend a stop loss and take profit automatically as they can be calculated mathematically. This software can be a part of a trading strategy that gets its input values from the pattern and derives a final conclusion by combining other indicators. Nevertheless, traders should study the pattern and learn to visually interpret them by repeated exercises. These exercises will definitely assist the trader to validate those signals provided by the software.
Difference between Bullish and Bearish Engulfing Candle
In theory, there is no difference in the construction of the Bullish and Bearish patterns. They are both the same. The Bullish pattern occurs during the end of a downtrend and the Bearish pattern occurs at the end of an uptrend. Moreover, both signal the trend reversals.
It should be emphasized that both of them rely on the validation of the pattern using price action. Most of the failures of trading the pattern are due to the hasty decision of the trader and the failure to identify the price action. It is critical to validate using the price action for the success for best trading results.
Also read: Bull Trap
The Bullish engulfing pattern and the Bearish engulfing pattern are both reversal patterns in many cases. They provide the best results when formed at the end of a trend and obviously make way for trend reversal. However, they may form as a continuation pattern. These continuation patterns may form after a considerable period of price consolidation. The price breaks the range and then continues to move in the direction of the previous trend without reversing the initial trend. As discussed earlier the price action and the structure of the subsequent candles provide further confirmation of the trend. Traders should be aware that trend reversals are prone to false starts.
Limitations of the Engulfing candle
The limitations of the engulfing candle are primarily limited in identifying the proper candles. Traders tend to look at the two candles related to the engulfing but ignore other market signals. Engulfing candles need additional confirmation of price action to be validated and acted upon. An engulfing candle without the subsequent price action is just a normal candle. New and exciting Forex traders jump into action once they spot the engulfing candle. The breakout of the high of the engulfing candle by the subsequent candle is as essential as the engulfing itself. Equally important are the structure of the candle and the momentum of the engulfing candle. Finally, increased volumes are often overlooked and traders jump into trades without checking the volume information.
It is often noted by technical analysts that price tends to retrace after the formation of the engulfing candle and the subsequent candles. However, these candles could be considered as entry points at pullbacks. The stop loss and take profit measurements are clearly defined by the length of the engulfing candle and the previous candle. Many traders tend to place the stop loss too close, though the best stop loss placement is at the previous swing high/low. As a result, many traders tend to get stopped prematurely. Similarly, the best take profit is the total length of the pattern. However, Forex traders tend to wait for too long or keep the take profit open, only for the markets to retrace and lose on the profits.
All patterns have a rate of failure due to the nature of the financial markets. So traders should calculate their risk and use the leverage appropriately. Though the engulfing pattern has a good rate of success traders should avoid taking excessive risk.
The engulfing candle pattern is an important candlestick pattern that provides the forex trader with a complete view of the market. The multiple information they provide is valuable to every forex trader. Furthermore, the patterns can be incorporated with many automated trading systems with ease. Much automated software currently assist the trader to identify the engulfing patterns and automatically provide the designated stop loss and take profit levels. However, every pattern trader or technical trader can easily get trained and accustomed to the pattern and trade then manually with the best results. Though the pattern has limitations as it requires validation by subsequent price action, the engulfing pattern has delivered reasonable trading results. Additionally, the pattern occurs frequently and can be found in all chart time frames. The patterns which form in forex, stocks, cryptos, options, indices, and other financial instruments are definitely worth mastering.