The Trading Bible Blog ᑕ❶ᑐ Engulfing Candlestick: Patterns, Meaning, Indicators

Engulfing Candlestick Patterns - Forex Trader’s Guide

By Stelian Olar, Updated on: Jul 12 2024.

Have you ever looked at a chart and seen a candle completely engulf the previous candle?

Me too.

At first, these engulfing candlestick patterns looked so cool - like a snake swallowing its prey whole.

Engulfing patterns can be major signals that mark a potential reversal in trend. I used to ignore them, but once I started paying attention, they helped me avoid mistakes and even catch some winning trades.

I know Forex charts can start to feel like a foreign language, but trust me, learning to recognize the engulfed candlestick will level up your price action trading game.

In this article, we'll break down:

• What is engulfing candlestick pattern
• The psychology behind engulfing candles
• Types of engulfing candlestick
• How to trade engulfing candlestick when you see one

I'll share the best trading strategies I've learned over my years of trading, including how engulfing candles work with support, resistance and other technical indicators.

My goal is to turn these patterns from cryptic candles into clear trading signals for you.

The key is knowing what to look for and how to interpret it in the context of the current market environment. By the end, you'll have a new tool in your trading toolbox.

Let's dive in!

What Is Engulfing Candlestick Pattern

The engulfing candlestick forms when a single candle completely engulfs or "swallows" the candle before it. Its broad real body visually pushes the price in the opposite direction of the previous candle. This signals potential trend reversals, making engulfing patterns one of the most popular chart patterns in technical analysis.

The engulfing candlestick pattern meaning is that the momentum in direction has shifted, with the new candle engulfing or "consuming" the previous candle. The shadows or wicks of the candles are not relevant. It's the relationship between the candle bodies that matters.

The color contrast of the candle bodies reinforces the reversal message. When properly identified, engulfing patterns can alert traders to a shift in market sentiment and new emerging trends.

Bullish and Bearish Engulfing Candlestick Patterns

As mentioned, there are two main types of engulfing candlesticks to watch for - bullish and bearish. Let's break down the difference:

Bullish Engulfing Candlestick

A bullish engulfing candlestick forms when a green (or white) up candle completely engulfs a small red (or black) down candle. The bullish candle's body must cover the entire real body of the previous bearish candle, without regard to shadows.

This shows upside momentum overtaking the prior down move. The bulls have woken up and are taking control back from the bears signaling potential bottoming action and reversal up from a downtrend.

Bearish Engulfing Candlestick

A bearish engulfing candlestick is the opposite, formed by a red (or black) down candle engulfing a small green (or white) up candle. Again, the engulfing candle's body must fully cover or consume the body of the previous candle, ignoring shadows.

This reflects strong downside momentum overwhelming the prior upswing. The bears have now wrestled control back from the bulls signaling potential topping action and reversal down from an uptrend.

The larger the engulfing candle compared to the previous candle, the more powerful the reversal signal. Gaining familiarity with bullish and bearish engulfing candlestick patterns takes chart time, but being able to quickly recognize engulfing candles adds a valuable tool for timing entries and exits.

Let's look closer at how to spot them on the charts.

Examples of Engulfing Candlestick Patterns

Below you can see some real examples of engulfing candlestick patterns:

Common Types of Engulfing Candlesticks

Beyond the standard bullish engulfing pattern and bearish engulfing pattern, there are a few common variations to be aware of. These include:

1. Piercing Line and Dark Cloud Cover – These are modified versions of the bullish engulfing candle being a bullish reversal pattern that forms in a downtrend. It contains a long red down candle followed by a green up candle that opens sharply lower but then closes more than halfway into the body of the first candle. The dark cloud cover is the opposite bearish pattern in an uptrend.
2. Outside Reversal – In an outside reversal, the engulfing candle makes a new high or low beyond the previous candle's range, showing strong momentum. A bullish outside reversal forms when the engulfing up candle breaks the low of the previous down candle. A bearish outside reversal sees the engulfing down candle breaking the high of the previous up candle.
3. Hidden Engulfing Candlestick – In this more subtle pattern, the engulfing candle body fully engulfs the previous candle body but its opening and closing price stay within the range of the previous candle's body. Since it is not as visually apparent, this requires closer chart inspection.

How to Trade the Engulfing Candlestick Pattern

The standard way of trading engulfing candlestick is to enter positions in the direction of the expected reversal and place stop losses on the other side of the engulfing bar:

1. For bullish engulfing bars, open long positions on a break above the high of the engulfing candle. Place stop losses below the low of the bullish engulfing bar.
2. For bearish engulfing bars, look to take short positions on a break below the low of the bearish engulfing candle. Set stop losses above the high of the engulfing bar.

Trading engulfing bar allows getting in early on the momentum shift signaled by the engulfing pattern, while defining the risk on the trade. The size of the stop loss compared to your entry determines the risk to reward ratio for the setup.

Engulfing Candle Trading Strategies

Here are some effective trading strategies to use with the engulfing bar candlestick pattern:

Combine With Support/Resistance

Plot major support and resistance levels on your chart and watch engulfing candles taking out these key zones acting as continuation patterns or bouncing leading to a sustained trend reversal. As a general rule, the more times a level has been tested, the weaker it becomes.

Use Moving Averages

Another engulfing candlestick strategy is the crossovers between price and a moving average indicator which can confirm whether an engulfing reversal may succeed or fail. If the price is rejected at the moving average and in the process it forms an engulfing candle, it warns the reversal may be underway.

Watch Momentum Divergence

If momentum is diverging during an engulfing pattern, it signals strength in the reversal. For example, in an uptrend, if price makes a new high on a bearish engulfing bar but momentum is failing to confirm with lower highs, the uptrend is likely about to reverse.

Engulfing patterns become much more robust when combined with other confluence factors to confirm whether the reversal will succeed or fail. Layering engulfing candlestick indicators and smart risk management transforms simple engulfing bars into an actionable strategy.

How Reliable are Engulfing Candlestick Patterns

According to Thomas Bulkowski, an expert in chart pattern analysis, the reliability of engulfing candlestick patterns depends on certain factors:

• In an analysis of over 700 stocks from 1991-1995, engulfing patterns predicted the direction of the next price move correctly around 65% of the time, with bullish engulfing candlestick patterns tending to be slightly more reliable than bearish.
• The larger the engulfing bar's body relative to the previous candle's body, the more reliable the pattern became, up to a success rate of 80% for engulfing candles with bodies over 3x the size of the previous candle's body.
• Engulfing patterns tend to be more reliable on daily charts versus shorter timeframes. Bulkowski found reliability on daily charts around 70%, versus 60-65% on hourly charts.

Trading Tips for Engulfing Candlestick Patterns

No single trading indicator or candlestick pattern works perfectly on its own and the engulfing candlestick patterns are no exception. Here are a few trading tips to stack the odds in your favor:

1. Engulfing patterns are more reliable when they align with the dominant trend. For example, bullish engulfing bars are more robust reversal signals in a broader uptrend.
2. Larger engulfing bodies signal stronger momentum and a higher probability reversal. Giant engulfing candles are more significant than small ones.
3. Confirm the pattern with other indicators.
4. The more often a level is tested, the weaker it becomes. So engulfing bars at well-established support/resistance have a higher chance of breaking the level.
5. Volatile trading conditions like news events, economic reports, or late day trading can generate less reliable engulfing patterns.
6. Use risk management principles like appropriate stop losses in case the pattern fails.

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