Engulfing Candle
An engulfing candlestick sounds like something that would set your house on fire, but it’s one of the imaginative names for trading patterns on a chart. The engulfing candle pattern can tell you when an upward or downward trend is reversing. Use this guide to understand how to recognize this type of candle. And more importantly, use it to create an entry and exit strategy for each trade. You can boost your trading success by understanding this one candlestick pattern. Candlestick trading was created way back in the 18th century Munehisa Homma, who used them to trade rice. Engulfing candlesticks were one of his early developments. Steve Nison brought the concept to the West with his book a Japanese Candlestick Charting Techniques. The engulfing candle became prominent because it is easy to recognize.
What is a bullish engulfing candle?
A bullish engulfing pattern indicates the price action may reverse its downward trend and start a new uptrend. “Engulfing” refers to the fact that the body of the candle goes both higher and lower than the previous candle. This is what an engulfing candle looks like. The price dropped at first, then buyers stepped in and drove the price up. This pattern appears at the bottom of a downtrend. How can you be sure it is the bottom? You cannot. But the bullish engulfing pattern indicates it could be. We will discuss how to get in and protect yourself later.
What is a bearish engulfing candle?
A bearish engulfing candle suggests the price action will reverse into a downtrend. The upward trend tops out at a candle that shows the trend tried to continue upward, but sellers took over and the price closed lower. Although buyers have tried to push the price higher they have failed, which explains why there are bar chart was initially positive for buyers. No pattern is a sure thing, but this bearish candlestick pattern is a strong indicator. Learning to use it correctly is what you need to work next!
Educate yourself about the basics
Books
Books about candlesticks can walk you through best practices. Look for books that offer a nuts-and-bolts approach instead of those that are trying to sell you a “secret method.”.
Here are two recommendations:
- Trade What You See–How to Profit from Pattern Recognition by Larry Pesavento
- Trading In The Zone by Mark Douglas
Trading Courses
If you are going to take a course on candlesticks, find one that offers basics and fundamentals. Avoid those that offer some kind of “trick” and promise outrageous returns.
Blogs
A good blog tells you how to do, not what to do. That means perhaps showing some candlestick patterns developing and commenting on them. Anyone who says “buy now” is being irresponsible. They do not know your trading goals and risk tolerance, and no trade is a sure thing.
Forums
Be careful with forums. Traders of all levels will weigh in on topics. You can get a lot of bad advice and believe some things that are not true. Use them to learn, but do not take any advice about jumping into a trade immediately.
Newsletters
These can be more useful than forums if they come from a seasoned pro. Avoid get-rich-quick newsletters.
Podcasts
Timely, meaning many podcasts will comment on the current market and candlestick setups they observe. Do not rush to make a trade just because you hear it is a good idea. You must understand why it is good.
YouTube
Sadly, YouTube is the gathering place for pitching the uninformed courses and books that overpromise and under-deliver. Be wary when someone waves fists-full of cash at the camera.
Webinars
Free webinars are usually teasers to sell you something. You can learn from them, but beware of pitches that get you over-enthused or fearful. You can make bad decisions when you are emotional.
Establish whether engulfing candle patterns are for you
Engulfing patterns can be useful, but you have to be prepared to embrace technical trading. This type of trading evaluates trades based on price chart patterns, rather than merely looking at underlying economic and financial conditions.
What do you have to be prepared to do:
- Watch a chart daily. You have to see the trade set-up, not just the engulfing candle. The pattern requires a trend leading to it.
- Act within one to three days. The purpose of getting into a reversal trade is to get in soon.
- Protect yourself from losses. Place a stop-loss order or watch the pattern daily to see if the change in the chart’s direction gets confirmed.
Manage your expectations
Candlesticks occasionally require quick action, but your approach overall should be long-term. Follow long trends in a chart and do not panic every time there is a small drop. Watch your candlesticks to see if a drop is a reversal or a mild pullback.
Candlesticks can tell you when to get in, but they cannot tell you what to get into. Choose your investments for the long term and use candlesticks to determine entry and exit points.
Risk management
There is no such thing as a sure thing in investing. Never invest more than 1-2% of your trading account value in any trade.
Use stop-loss orders to get out of your position automatically if you start to lose too much. Lose a battle to fight another day and win the war.
Select a proven strategy with objective rules for entry and exit.
One of the biggest mistakes traders make is changing their investment strategy. Candlesticks are a technical trading method, meaning they rely on chart patterns. When you hear about a company that is a “hot stock” and decide to buy stock, or when you hear about a favorable exchange rate, you are using a fundamental approach. Do not keep changing your approach or you will lose focus and chase the latest information.
Open a demo account with a reputable trading platform
Look for a platform that offers safety measures to protect your money and is regulated by the country where it is located.
Here are some suggestions:
- IG Index
Trade global currency markets with spot Forex trading. - eToro
This is a social trading platform. You can copy the trades of other members and invest in multiple assets, including cryptocurrencies. - AvaTrade
AVA boasts strong security and offers multiple assets for traders on six continents - XTB
X-Trade Brokers access to hundreds of markets worldwide. - FP Markets First Prudential Markets works out of Australia but offers global Forex trading.
- NAGA Markets
Naga allows you to trade stocks, commodities, Forex and ETFs globally in real time. - Forex.com
This Forex trading platform boasts strong security and regulation compliance.
Keep a trade journal of the trades you make
Use a spreadsheet or journal to track your trades. Note your winners and losers and review why the outcomes occurred. Did you misread the candlesticks or was the market behaving in an unusual manner?
A bullish engulfing candle trading strategy
So how to get into (and out of) a trade when you see a bullish engulfing candle? Let’s break it down.
Trade entry
Enter the next day after the engulfing candle.
For greater safety, wait two days before entering to see if the upward reversal gets confirmed by more buying.
Wait for this pattern to fully form, meaning wait until trading ceases for the day. Then make your decision the next day, or wait a couple of days to see if more upward candles form.
Trade exit
It is difficult to set a price at which you will sell. Instead, keep an eye on this pattern and watch for a reversal in the other direction. Set a stop-loss order at the lowest price of the engulfing candlestick. Sell when you see a bearish trend reversal pattern. This is the earliest trade you should make. You can wait two or three days to see if the trading action confirms the reversal. Bullish engulfing candle trading strategy success rate. This pattern is reliable about 60% of the time. Note, however, that this pattern is most reliable at the bottom of a trend. A long downtrend will shake out all the sellers, and when buyers step in, the price action forms the bullish engulfing candle.
A bearish engulfing candle trading strategy
When an upward trend starts to reverse, look for the bearish engulfing candle, make sure you have a strategy in place. Do not improvise.
Trade entry
If you already have a long position, place a sell market order the day after the bearish engulfing candle is formed.
For those who short positions, short on the day after the bearish engulfing candle.
Trade exit
If you have shorted, get out of the short position the day after a bearish trend reversal. In the event you are waiting to go long, buy the day after a bullish trend reversal. You may be unsure on the first day after the engulfing candle, you may want to wait two or three days to see if the reversal gets confirmed. Bearish engulfing candle trading strategy success rate. This pattern is reliable 60-70% of the time. Note that it is most accurate at the top of an uptrend.
Which trading platform is best for beginners?
While many trading platforms are good, some are better for beginners. Go here to find some good suggestions for those just starting out.
Trading styles and alternative reversal patterns to engulfing candles
- Hammer
The hammer pattern can be bullish or bearish, depending on where it forms. It indicates that there was a reversal during the day, and it can mean a new trend is beginning. - Piercing Line
The piercing line pattern can be difficult to spot because you have to find the halfway point in the previous candle, and of course, the line is not drawn for you. - Morning Star
This requires at least three candles before you can identify it. It is not as easy to spot as an engulfing candle, but it is just as useful
- Three White Soldiers
This is very reliable. An engulfing candle followed by three white soldiers is really strong. It shows follow through on the revers
- Hanging man
The hanging man pattern looks like a hammer but occurs after a short rise in price action. How can you tell the difference? The best way is to wait for two or three days to see confirmation. - Shooting star
This looks like a hammer but there is no wick below the body. In other words, it closed at its lowest price. It is a bearish reversal pattern
- Dark Cloud cover
This is a bearish reversal pattern. It does not “engulf” but it closes below the halfway point of the previous candle. Wait for two or three days to confirm the new direction.
8 Pro tips for successfully trading the engulfing candle pattern
Success with candlesticks is as much an art as a science. You use them to gauge the psychology of traders, and that interpretation can be subjective. Make up stories with them: “This candle shows that buyers were eager at first but something spooked them and they started selling.”
- How best to use engulfing candles.
Do not just look for engulfing candles and jump into a trade. Understand them, look at the trend, make sure you “get it.” Mindlessly trading candlestick patterns is a sure way to run into trouble. Trade them on paper for a bit (without actually investing any money) and see if your notions are borne out. - When you should avoid using them.
When the market is volatile–extreme ups and downs in a short period–candlestick patterns can be unreliable. They are best used as indicators after long trends, not short-term fluctuations. - Which is the best time frame to use.
At first glance, candlesticks look like a way to get in and make fast money. But use them as entry points for long-term investing. That will calm you down and prevent panicky decisions. - The role of the wick in engulfing candles.
The wick shows how high and low the price went that day, whereas the body shows the open and close. - Engulfing candlesticks are no more reliable than most reversal patterns.
Though the engulfing candle is very popular, that does not mean it is more reliable. Do not rely on one single pattern to make your trading decisions. - Predicting the formation of an engulfing candle.
Do not do it. Leave fortune-telling to the wishful thinkers. Candlesticks show you what happened, and you should not try to guess when one will form. - Using engulfing candles with other patterns.
The Three White Soldiers pattern and the Three Black Crows pattern work well with engulfing candles as a confirmation of the new direction. - Getting scared when there is no confirmation.
If you make a trade based on an engulfing candle and the chart does not make a decent move in either direction, do not assume it fizzled out. Confirmation can come several days after an engulfing candle. Stay out of the fortune-telling business. Do not trade based on fear.
What are the risks of the engulfing candle pattern?
Engulfing candles are a one-day event. Though many use them to get into the trade the next day, the market can be finicky. Always set stop-loss orders.
Also, engulfing candles do not take into account the fundamentals of the underlying investment. Make sure the investment makes sense in terms of sound economics or finances.
Another risk is focusing on one to three days of candlesticks. Zoom out on a chart and look at the larger trend.
Conclusion
Engulfing candles can be easy to find, and often serve as strong indicators or a new direction. They are suggestions, possibilities. Know them well and practice using them, and you will become adept at using them. Do not get overexcited when you find one. Be patient, watch it, and if you trade based on it, watch it daily for surprises.
Frequently asked questions (FAQs)
Q: Can you teach yourself how to use the engulfing candle pattern?
A: You now only can teach yourself, you should. Even guidance from courses requires you to internalize the lessons and make judgments for yourself. Make sure you use credible sources for learning candlesticks and the engulfing pattern, and do not forget that you can be a credible source. That means that at some point you should have your own insights and not wait for others to give them to you.
Q: How do I know when to use them?
A: Use them as part of every analysis you do. They are a tool in your toolbox, now a replacement for good judgment.
Q: What are the weaknesses of using engulfing candles?
A: An engulfing candle is not 100% reliable. Until you learn to spot good entry points after an engulfing candle, wait for two or three days to see if a reversal direction gets confirmed.
Q: Do people fail when using engulfing candlesticks?
A: Yes. Many do. But that is not because these candlesticks are not good to use, it is because many trade on a superficial level, jumping in when they see one without an exit plan, an understanding of the underlying investment vehicle, and an awareness of the economy.
