In this review, we will analyze the features of formation and trading by the Engulfing pattern. This pattern from candlestick analysis is clearly visible on the chart and heralds a reversal of the current trend.
How is the Engulfing pattern formed?
The Engulfing pattern is a reversal candlestick pattern that forms at the local highs and lows of the price chart during an uptrend or downtrend. This pattern consists of two candles: the first candlestick has a relatively small body, and the second has an opposite color and a larger body, which completely covers (absorbs) the first candlestick.
From the point of view of the behavior of market participants, the appearance of the Engulfing pattern on the chart means that the strength of the current trend is drying up, the pace is losing – this is evidenced by the small size of the first absorbed candlestick. The previous movement loses its strength, the market is in a state of precarious equilibrium.
The appearance of the next powerful candlestick of the pattern, which engulfed the previous one and closed in the opposite direction, indicates the beginning of a correction, which may even turn into a reversal of the current trend.
Types of the “Absorption” pattern
Depending on the color of the second engulfing candlestick, the pattern is divided into two types: “Bullish engulfing” and “Bearish engulfing”.
It is formed during a downward movement at the local minimums of the price chart. The first small black candlestick of the pattern shows that the bears are already running out, after which a large white candle appears, completely engulfing the body of the first. This suggests that the bulls felt the weakness of the bears and actively launched an offensive.
Further upward price movement leads to the beginning of an upward correction. Confirmation of its beginning is the growth of quotes above the high of the second, large bullish candlestick of the pattern.
It is formed during an upward price impulse at the local highs of the chart. The first small white candlestick of the pattern indicates that the bulls are already tired and need a break. A large black candle that appeared next, absorbing the white one with its body, indicates that the bears took advantage of the situation and actively launched a counteroffensive.
Further downward movement of quotes leads to the beginning of a downward correction. Confirmation of the beginning of the downward movement will be the price drop below the low of the second, large bearish candlestick of the pattern.
Trading on the “Engulfing” pattern
Since the Engulfing pattern is a reversal pattern, an upward or downward price movement should be observed before its appearance, it is better to ignore it in the sideways. For trading, it is recommended to use higher timeframes: from H1 and higher, as well as highly liquid assets: currency pairs, gold, oil, stocks, stock indices.
“Bullish engulfing” – buy
The trading algorithm for a bullish pattern looks like this:
- In the course of the downward movement at the local minimums of the price chart, a “Bullish Engulfing” reversal candlestick pattern is formed.
- You can open a buy position after the price exceeds the maximum of the absorbing large white candlestick (the second candlestick of the pattern).
- After opening a position, Stop Loss is set just below the lowest low of both candlesticks of the pattern.
- Profit can be fixed when the price reaches a significant resistance level or when signs of a downward price reversal appear.
“Bearish engulfing” – sell
The algorithm for trading a bearish pattern is as follows:
- In the course of an upward trend at the local highs of the price chart, a bearish engulfing reversal candlestick pattern is formed.
- You can open a sell position after the quotes drop below the low of the engulfing large black candlestick (the second candlestick of the pattern).
- After entering the market, the Stop Loss is set just above the highest high of both candlesticks of the pattern.
- It will be possible to fix Profit when the price reaches a significant support level, or when signals about a price reversal appear.
What enhances the “Absorption” pattern
Steve Nison, a well-known trader and analyst, popularizer of candlestick analysis, identifies several factors that “strengthen” or increase the likelihood of the Engulfing pattern being worked out:
- The place of the pattern formation coincides with the classic technical analysis support and resistance levels.
- The first candlestick of the pattern is presented as a “doji” – this candle has practically no body, the opening and closing prices are very close or completely coincide. The appearance of the Doji speaks of uncertainty in the market and heralds a possible reversal.
- Complete absorption occurs, the shadows of the second large absorbing candlestick completely overlap the shadows of the first. That is, not only the body of the first candlestick is within the body of the second, but its maximum and minimum are also within the extrema of the second (large) candlestick of the pattern.
“Bullish Engulfing” and “Bearish Engulfing” reversal candlestick patterns are formed at the local extremes of the price chart during an upward or downward trend. Their appearance on the chart foreshadows a possible beginning of a correction or even a trend reversal.
The probability of working out these patterns increases with the appearance of amplifying factors, as well as in combination with technical analysis patterns, support and resistance levels, signals of trading indicators. Before starting real trading, you should practice using these patterns on a demo account.
You can get acquainted with other candlestick patterns in this article: