The Engulfing Candlestick Pattern forms an effective and widely acknowledged reversal indicator when trading in forex. This article describes the key elements that constitute the Engulfing Candlestick Pattern, a method of identification, and ways to trade on it successfully.
This will serve as a trusted weapon for traders whether the pattern happens to be bullish or bearish in their quest to capitalize on the reversals in the market.
The Engulfing Candlestick Pattern is formed when a larger candlestick completely engulfs the body of a smaller candlestick that precedes it, signaling that a reversal in the trend may be near. These can be of two types:
Bullish Engulfing
- This occurs when there is an end in the downtrend, changing to an upward trend.
Bearish Engulfing
- These are at the end of an uptrend and tell of a movement into a downtrend.
This pattern is quite dramatic in appearance and reflects the balance of power between buyers and sellers. Hence, it has become a favorite among traders for marking potential turning points.
Engulfing Candlestick Pattern – How to Identify
Look for Two Back-to-Back Candlesticks
- The first one is smaller, representing the existing trend.
- The second is bigger and completely engulfs the body of the first candle.
Disregard the wicks and focus on the bodies of the candles. The bigger candlestick should completely engulf the body of the other one.
Confirm the Context
- A Bullish Engulfing Pattern forms after a downtrend, and it signals a reversal to the upside.
- A Bearish Engulfing Pattern follows an uptrend and shows a downside reversal.
How to Trade the Engulfing Candlestick Pattern
Steps to Trade
1. Identify the Pattern
- Find a bullish or bearish engulfing candle on your price chart.
2. Confirm the Signal
- Confirm the pattern with other tools, like Fibonacci retracements, MACD, or moving averages.
3. Enter the Trade
- Bullish Engulfing Pattern: Enter a long position at the close of the bullish candle.
- Bearish Engulfing Pattern: Enter a short position at the close of the bearish candle.
4. Set Stop Loss
- For a bullish pattern: Place the stop loss just below the engulfing candle.
- For a bearish pattern: Place the stop loss just above the engulfing candle.
5. Take Profit
- Exit or take profit at a 1:1 risk-to-reward ratio or at key support/resistance levels.
Example
Bullish Engulfing Pattern
- A small bearish candle is followed by a large bullish candle that engulfs it.
- Entry: Buy at the close of the bullish candle.
- Stop Loss: Slightly below the low of the bullish engulfing candle.
- Target: Take profit at a 1:1 risk-to-reward level or at the next resistance level.
Bearish Engulfing Pattern
- It starts with a small bullish candle followed by a large bearish candle.
- Entry: Place a sell order at the close of the bearish candle.
- Stop Loss: Above the high of the bearish engulfing candle.
- Target: Place your take profit at a 1:1 risk-to-reward level or at the next support.
Pros and Cons of the Engulfing Candlestick Pattern
Pros
- Easy to Recognize: The pattern is highly visible and thus easy to recognize.
- Frequency: Found on all forex pairs and timeframes.
- Effective Reversals: Provides reliable reversal signals when confirmed with other indicators.
Cons
- False Signals: In a choppy market, this may lead to the generation of invalid reversals.
- Large Stop Losses: Stop losses can be wide on higher time frames.
- Limited Accuracy in Short Time Frames: Effectiveness decreases in one-minute or five-minute charts.
Key Takeaways
- The Engulfing Candlestick Pattern is one of the most reliable reversal indicators that gives very distinct buy and sell signals.
- It is always good to confirm the pattern with other indicators or tools for better precision.
- Always use sound risk management to handle every false signal or adverse condition of the market.
For traders looking to refine their skills, incorporating this pattern into their strategy provides a robust method for capitalizing on market reversals.
