Candlestick patterns are an essential component of price action analysis. Candlestick formations can provide high probability signals about a potential outcome on the price chart. Therefore, Forex traders should be aware of the various candlestick setups that can occur in the market. Today we will discuss one of these candlestick formations. This candlestick structure is called the Engulfing candlestick pattern. We will go through the functions of this chart figure and we will discuss a strategy for combining it with other forms of price action analysis.
This is how the Engulfing pattern appears on the chart. Notice that the bearish candle is fully engulfed by the body of the next candle which is bullish. The opposite scenario is possible too. The engulfed candle could be bullish and the engulfing candle could be bearish.
A valid bullish Engulfing pattern continues with a third candle (bullish), which breaks the body of the engulfing candle upwards. A valid bearish Engulfing pattern continues with a third candle (bearish), which breaks the body of the engulfing candle downwards. This is how the Engulfing confirmation appears on the chart:
The best place for a stop loss order in an Engulfing trade is beyond the Engulfing pattern extreme. This would mean that if the Engulfing setup is bullish, the Stop Loss order should be placed under the lower candlewick of the engulfing candle. If the Engulfing setup is bearish, then the Stop Loss order should be located above the upper candlewick of the engulfing candle.
A rule of thumb is that an Engulfing trade should be held for at least the price move equal to the size of the pattern. This means that the minimum you should pursue from an Engulfing pattern should equal the distance between the tips of the upper and the lower candlewick of the engulfing candle.
However, a confirmation candle needs to appear before we can consider taking a position in this case. The next candle on the chart is bearish again and closes below the body of the engulfing candle. This is the confirmation needed to take a trade based on this bearish Engulfing pattern. The stop loss order for this trade should be located above the upper wick of the engulfing candle as shown on the image.
Many trading strategies use Engulfing candlestick patterns as a signal for significant trend reversals. However, reversal trading typically involves a lower probability with a higher reward. While some traders are comfortable with that risk profile, others might feel safer going with the trend.
Observing swing highs and lows is the simplest way to track the market structure. While you can do this without any trading indicator, new price action traders might want to use moving averages to help with establishing consistency.
How we interpret the engulfing pattern can provide us with a further understanding of the current market sentiment, whatever form it might take. In return, this can help us better assess the probabilities of success behind each individual bearish and bullish engulfing pattern.
In technical analysis, the engulfing pattern is multiple candlestick patterns (2-candle pattern) that can signal a trend reversal or a trend continuation depending on where it develops in relation to the prevailing trend.
The bullish engulfing pattern is a combination of one bearish candlestick followed by a bullish candlestick that engulfs the entire body and wicks of the first candle. This shows that, generally, the broader market is moving in a positive direction.
On the other hand, the bearish engulfing pattern is the opposite of the bullish engulfing pattern. The bearish engulfing pattern can signal the possible start of a new downtrend. While these engulfing patterns do occur in the opposite direction, they are still governed by the same underlying principles.
Using strict risk management rules, we can hide our stop loss above the high of the second candle. Usually, the engulfing pattern can boost attractive risk-reward ratios so you can capture profits at least 3 times your risk.
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