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Reversal Patterns. Engulfing Candlestick Pattern

Adam Lienhard
Reversal Patterns. Engulfing Candlestick Pattern

The engulfing candlestick pattern is a crucial indicator in technical analysis for stock trading, signaling a possible shift (a reversal) in the prevailing market trend. This pattern is characterized by two candlesticks where the body of the second candlestick entirely covers or envelops the body of the first. There are two distinct forms of the engulfing candlestick pattern.

Bullish engulfing pattern

This pattern emerges when a minor black candlestick is succeeded by a substantial white candlestick on the following day. It manifests within a downward trend and is composed of a dark candle followed by a larger hollow candle. Despite opening below the prior low, the buying momentum propels the price to exceed the previous high. It is recommended to initiate a long position when the price rises beyond the peak of the second candlestick in the pattern.

Bearish engulfing pattern

This is the inverse of the bullish pattern. It offers the most robust signal when it appears at the pinnacle of an upward trend, suggesting an increase in selling pressure. The pattern features two candles, with the second one fully consuming the ‘body’ of the preceding green candle. The price movement should clearly indicate an uptrend before the bearish pattern appears.

These patterns are typically more reliable in predicting reversals when they are preceded by four or more consecutive black candlesticks. Traders should pay attention to not just the two candlesticks forming the engulfing pattern but also the preceding ones for a comprehensive understanding of the market dynamics.

How to use an engulfing candlestick in trading

When employing the engulfing candlestick pattern in trading, it’s essential to recognize the pattern on price charts and make strategic decisions based on its presence. Here’s a guide to using this pattern effectively.

1. Identify the pattern.

Search for the engulfing pattern on your chart. It is a dual candlestick pattern and comprises two candles; the initial one is smaller (bullish or bearish), and the subsequent one wholly envelops the initial candle.

The color of the subsequent candle dictates if it’s a bullish or bearish engulfing pattern.

Bullish engulfingBearish engulfing
Appears after a downward trend. The initial candle is bearish (with a smaller body), and the succeeding one is bullish (with a larger body). The succeeding candle’s body fully encloses the initial candle’s body. Contemplate going long when the price ascends past the high of the second candle.Emerges after an upward trend. The initial candle is bullish (with a smaller body), and the succeeding one is bearish (with a larger body). The succeeding candle’s body fully encloses the initial candle’s body. Think about going short when the price descends beneath the low of the second candle.

2. Validation and risk mitigation.

Before you make any rash decisions, you need to validate the pattern by examining other technical indicators (such as trend lines, Moving Averages, support/resistance levels). Don’t forget to implement Stop-Loss orders to cap potential losses.

Remember: it’s always crucial to take into account the wider market conditions and refrain from trading against dominant trends.

3. Timeframes and market dynamics.

Engulfing patterns tend to be more dependable on longer timeframes (like daily or weekly charts). Before executing a trade, reflect on the larger market environment (including fundamentals and news events).

Summary: Engulfing pattern

The engulfing pattern is one of the more reliable reversal patterns in technical analysis. Recall that no single pattern guarantees success, and prudent risk management is always paramount. Regularly apply sound risk control measures and utilize Stop-Loss orders to safeguard your investment. Moreover, integrating the engulfing pattern with other technical analysis instruments can enhance the precision of your trading choices.

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