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1. What is an Engulfing Candle? How many types of Engulfing Candles?
There are two types of engulfing candles:
Bullish Engulfing Pattern:
- This pattern consists of two candles signaling a potential strong price increase. It appears when a bearish (downward) candle is followed by a large bullish (upward) candle that completely engulfs the previous bearish candle. This indicates that buyers have decided to push the price up significantly after a period of decline or consolidation.
Bearish Engulfing Pattern:
- In contrast to the bullish engulfing pattern, this pattern occurs when a bullish candle is followed by a large bearish candle that completely engulfs the previous bullish candle. This suggests that sellers have taken full control and a significant downward movement may occur.
The engulfing candle pattern is a strong reversal signal, and it is important to carefully analyze these patterns when they appear.
2. How to Identify an Engulfing Candle
- Previous Price Trend: The engulfing candle pattern signals a trend reversal, so it typically appears either at the peak or the bottom of a trend. For a bullish engulfing pattern, the previous trend must be bearish (downward), while for a bearish engulfing pattern, the previous trend must be bullish (upward).
- Candle Body: In an engulfing candle pattern, the body of the second candle must be larger and completely cover the body of the previous candle to be considered a true engulfing pattern. For a bullish engulfing pattern, the second candle has a large body that completely covers the previous bearish (red) candle.
- Trading Volume: To assess the effectiveness of an engulfing candle, pay attention to the trading volume. Because the price is driven strongly and the second candle completely covers the first candle, the trading volume should be sufficiently large. If not, it might indicate a false breakout or a corrective wave. Therefore, to increase reliability, the volume of the engulfing candle should be high. This means the volume bar should be significantly higher than the surrounding volume bars or exceed the average trading volume.
If you’ve read the previous article, you’ll definitely enjoy the following section, which covers trading strategies:
First, let’s explore how to place trades and set stop losses.
With the engulfing candle pattern, there are two entry points: one is at the closing price of the candle, and the other is at the midpoint of the candle's body. In some cases, depending on the previous candle's body, the price may retrace to the high of the previous candle before starting the new trend. When trading with an engulfing candle pattern, you should set your stop loss below the engulfing candle cluster. It’s best to place the stop loss slightly beyond the pattern to avoid being stopped out by market fluctuations.
Example of placing an order with the Engulfing Candle Pattern:
After learning how to place orders, let’s now dive into trading strategies using the engulfing candle pattern.
Similar to trading strategies with hammer candles, you can also apply the engulfing candle pattern to similar strategies.
Strategy 1: Combining Engulfing Candles with Support and Resistance Zones
With this strategy, you need to identify which price levels act as support and resistance, then observe the price action. If the price approaches a support or resistance zone and an engulfing candle pattern appears, you can consider opening a trade. Remember that you should only open a trade when the entire engulfing candle pattern is complete.
Here is an illustrative example of a bearish engulfing pattern occurring at a market resistance zone.
In this example, the price zone of 7140-7180 was where the price consolidated in the previous trend. At the point when the price chart broke down, the upward trend came back to test the resistance. During this first test, an engulfing candle pattern appeared. After this pattern emerged, the following trading session saw the price continue to decrease. In the subsequent test, the price chart did not show another engulfing candle, and the price managed to break through the resistance and continue to rise. The reasons for this occurrence will be explained in more detail in the article on resistance and support.
Strategy 2: Applying Combination with Divergence or RSI Indicator Overbought/Oversold Conditions
This is a classic case with a high probability of accuracy.
Example of a bearish engulfing pattern occurring when RSI approaches oversold conditions and divergence appears
When the RSI indicator approaches oversold or overbought conditions and a bearish engulfing pattern appears, it is important to consider a potential trend reversal, especially in higher time frames where the effectiveness of such patterns is generally higher.
In this article, I will focus on the RSI approaching oversold conditions. For divergence, I will provide a more detailed guide in the article about RSI, as it is quite complex. This article aims to help you understand the nature of the engulfing candle pattern and how to trade it effectively before combining it with other indicators.
I hope this knowledge provides value and helps you navigate the challenging financial markets.
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