Author: Shanda Biggs
In our last post we discussed the pin bar setup. If you missed this post you definitely will want to take a look at it. Click here to go to the first post of our two part series on the most important candlestick patterns.
How to Identify an Engulfing Candlestick
Before diving into some examples of engulfings on the price chart we are going to take the time to diagnose how the pattern forms. In the image below you will see exactly how a textbook engulfing candlestick pattern looks.
For a bearish and bullish engulfings we look for the 2 candlesticks to form. The first candlestick in a bearish engulfing pattern will be an up candle, the second will be a down candle. The opposite would be true for a bullish engulfing. This two bar formation is very important because it gives us insights into whether the bulls or bears have control in the market.
When we see this two bar setup we want to ensure that the engulfing bar (second bar) is literally engulfing the first bar. This means that the second candlesticks body must engulf the first candlestick or be much larger than it.
This pattern is powerful as it symbolizes a shift in momentum. What we often see with good engulfing patterns is that for a bearish setup, the close of the second bar will be quite far away from the open of the first bar. If you look at the example above you can see that this is the case. The close of the red bearish bar is significantly lower than where the first bar opened. You will also notice that the wicks of the candles are very small or virtually non-existent.
What this shows is that sellers pushed prices down immediately. There was no test of previous highs or lows but rather a strong shift in momentum. This gives us clues into the collective market mind as we can see if buyers or sellers are gaining control.
In the above example, after the shift in momentum, prices sold off. Paying attention to engulfing bars and candlesticks with little to no wick is extremely important. If you spot an engulfing at a significant level on the chart this can be a very powerful reversal signal.
Trading Engulfings in the Correct Market Context
As we discussed in the pinbar post, identifying and trading engulfing candlesticks must be done in the correct market context. We want to ensure that price is nearing the end of a bearish or bullish run and is losing steam.
Take a look at the example below. Price has been trending up for the past 9 days. You can then see a powerful engulfing reversal signal at the highs of price action. The engulfing is showing that the daily momentum could be slowing down and potentially reversing in the coming days. Look at what happened next… price make a move to the downside.
Large engulfing candlesticks after a reversal can also be a great signal of market momentum and direction. If we see large candlesticks moving in one direction this can give us clues as to who has control, the bulls or the bears. If you look at the example below we can see that price has made a reversal after a bearish run in price. Two large bodied candles then formed and skyrocketed price to the upside. These large candles show us who has control in the markets and are a great way of determining market momentum. Being able to successfully interpret what these large engulfing candles are tell you will help you trade in line with the collective market.
Candlesticks provide a great way to interpret price action and analyze charts. When used in conjunction with your current trading routine they can literally change your trading. If you combine candlesticks with other price action analysis I have no doubt that your trading results will improve.
Japanese candlesticks are one of the oldest methods of visual representations on a chart. Great candlestick patterns have stood the test of time. At Evestin Forex we have developed a trading strategy that relies almost exclusively on candlesticks for entries. This allows us to take high probability setups on the daily chart. If you want to learn more about this particular strategy click here and we would be more then happy to show you how candlestick trading can change your life!