Billions of dollars are traded daily in financial markets
worldwide. Almost anyone with a bit of technical analysis knowledge can buy and
sell various assets in this wide global market using just the internet. One of
the key things to learn in technical analysis is Japanese candlesticks.
Candlesticks are a charting technique used to represent price movements of
financial assets like currency exchange rates. Japanese candlesticks are an
effective way to understand price movements and identify trends. Among the
various candlestick patterns, Engulfing candlesticks stand out as more
eye-catching and intriguing in the market. There are two types of this
candlestick pattern:
- Bearish Engulfing candlesticks
- Bullish Engulfing candlesticks
The Engulfing candlestick pattern is a chart pattern
consisting of two candlesticks. Engulfing candlestick patterns are a popular
technical analysis tool for both beginner and experienced traders.
Understanding these patterns can help us better understand market trends and
make smarter trading decisions.
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| Engulfing Candlestick Patterns |
Note: New traders in the financial markets may sometimes
confuse the Engulfing candlestick pattern with the Harami candlestick pattern.
However, there are some key differences between these two candlestick patterns.
The main difference is the size of the candles.
For example, in the Engulfing pattern, the first candle is much smaller
than the second candle, while in the Harami pattern, the opposite is true.
1. Bearish Engulfing candlesticks
Definition:
The Bearish Engulfing candlestick pattern is a candle pattern on a price chart that can indicate the end of an uptrend or a reversal. This pattern is characterized by a candlestick that follows an upward trend and is then engulfed downward by a subsequent candlestick. The first candle is usually a green or white bullish candle, while the second one appears as a larger red or black bearish candle that completely engulfs the body of the previous bullish candle.
Formation:
Bearish Engulfing Candlestick is a
two-candlestick pattern. It is formed when a black or red candle (the second
candle) completely engulfs a white or green candle (the first candle), and its
formation consists of the following steps:
- First Candlestick (Upward): This pattern usually occurs in an uptrend. The first candle is typically a green or white candle and often represents an increase. As prices are generally rising, this candle may have a smaller body.
- Second Candlestick (Downward): The following second candle is a larger red or black candle that engulfs the first candle downward. This candle usually has a larger body and encompasses the entire body of the previous bullish candle.
This situation indicates that the sellers are overwhelming
the buyers and that prices may be entering a downtrend. The Bearish Engulfing
pattern signals that selling pressure is increasing and that the downtrend may
be strengthening.
Interpretation:
Bearish Engulfing candlestick is a
formation within an uptrend that could indicate the beginning of a downtrend.
If the body of the second candle is larger than the body of the first candle,
it's interpreted as a stronger signal for a downtrend. So, at the peak of an
uptrend, if a large red (black) candle appears, it signals a strong downtrend,
whereas a small red (black) candle might indicate a weaker downtrend.
Additionally, if a Bearish Engulfing candlestick appears in an overbought zone or
at a resistance level, it can result in a more reliable signal.
Trading with Bearish Engulfing
Bearish Engulfing is often seen more prominently in uptrends, and we can think of it as a precursor to a downtrend. When this pattern appears on a price chart, we can open a Short position, taking into account the strength of the current trend and after confirmation with other technical analysis tools. Here is an example of trading on the Ethereum/Bitcoin daily chart:
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| Bearish Engulfing Candlestick Pattern in ETH/BTC chart |
Entry: For a short-term trade, the entry level is
typically placed below the low of the second candle. This is because the second
candle shows that the bears are in control and that the price is likely to
continue to fall.
Stop Loss: The stop-loss level is typically placed
above the high of the candles in which this pattern formed. This is because
these candles formed in a bullish trend and there is still a possibility that
the price could recover.
Target: The target level
can be determined by each trader according to their strategy. Support levels,
Fibonacci retracement levels, moving averages, risk/reward ratio, or other
technical indicators can also be used for the target level.
Remember, it can be risky to trade based on a single candle
in financial markets like Forex, where price fluctuations are common. Just like
any candlestick pattern, Bearish Engulfing can also produce false signals.
Therefore, it is important to not trade based on this pattern alone and to
confirm it using other technical analysis tools and indicators as well.
Adopting an integrated approach in trading can help you make more solid trading
decisions by using multiple confirmation methods instead of making decisions
based on a single indicator.
2. Bullish Engulfing candlesticks
Definition:
The Bullish Engulfing candlestick is a
candlestick formation that occurs within a downtrend and can indicate the
beginning of an uptrend. It's known as a two-candle pattern. The first candle
is a black or red candle representing the downtrend. The second candle is a
white or green candle that completely or partially engulfs the first candle.
This signifies a reversal in the direction of the current trend, either
partially or entirely.
Formation:
The Bullish Engulfing candlestick pattern
is a two-candlestick pattern that indicates the dominance of the bulls. The
first candle shows that the bears are dominant and that the price is likely to
continue to fall. However, the second candle shows that the bulls are dominant
and that the uptrend is likely to begin. This pattern typically occurs in a
downtrend and consists of two consecutive candlesticks:
- First Candlestick (Downward): This pattern generally appears at the end of a downtrend. The first candle usually emerges as a red or black bearish candle, often representing the downward movement. As prices are generally falling, this candle may have a smaller body.
- Second Candlestick (Upward): The subsequent second candle appears as a larger green or white bullish candle that completely engulfs or significantly surpasses the first candle. This second candle encompasses the entire body of the previous bearish candle.
This situation can indicate that buyers have overwhelmed
sellers and that prices might experience upward momentum. The Bullish Engulfing
pattern could suggest a strengthening uptrend and the potential end of a
downtrend.
Interpretation:
The Bullish Engulfing candlestick,
when appearing at the end of a downtrend, is interpreted as the beginning of an
upward trend. Therefore, this pattern indicates that the downtrend is weakening
and that a bullish reversal is possible. While the first bearish candle
indicates seller control, the second large bullish candle signifies buyer
strength and a possible shift in market direction. The second candle completely
engulfing or significantly surpassing the previous bearish candle indicates
buyer dominance and possible strengthening of the uptrend. If a large green
(white) candle appears at the bottom of a downtrend, it's a strong signal for
an upward trend, while a small green (white) candle might indicate a weaker
upward trend. Moreover, if a Bullish Engulfing candlestick appears in an
oversold zone, it can result in a more reliable signal.
Trading with Bullish Engulfing
When the Bullish Engulfing candlestick pattern is seen in
the market, we may consider taking a Long position. Of course, it is important
to avoid trading solely based on the Bullish Engulfing pattern. It would be
wise to enter a Buy order after confirming this pattern with other technical
indicators. Take a look at the trading example in the Bitcoin/USD daily chart
below:
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| Bullish Engulfing Candlestick Pattern in BTC/USD chart |
Entry: The entry level can commonly be either the
break above the top of the second (higher) candle, or an entry at a price close
to this level. This is because the second candle shows the dominance of the
bulls and that the price is likely to continue to rise.
Stop Loss: The stop-loss level is normally placed
below the low of the candles in which the pattern formed. This is because these
candles formed in a market where the bears were dominant and that the price is
likely to continue to fall.
Target: Any target can be set using technical
analysis tools such as resistance levels, Fibonacci extension levels, or
previous peak points. In addition, the classical method is to determine the
target level as a distance of twice the length of the body of the second
candle.
Don't forget. Forex is a risky financial market. Like any Japanese candlestick pattern, the Bullish Engulfing pattern is not infallible. Therefore, it is important to confirm the pattern with other technical analysis tools before trading based on a single indicator.