An engulfing pattern is a reversal candlestick pattern that can be bearish or bullish depending on whether it appears at the end of an uptrend or downtrend.
It is formed by two candles, where the body of the first candle is “engulfed” by the body of the second candle. It provides an approach for traders to enter the market in anticipation of a possible trend reversal.
The pattern formation consists of two candles.
The first candle is characterized by a small body, followed by a taller candle whose body completely engulfs the previous candle’s body.
There are two types of engulfing candlestick e patterns:
The Bullish Engulfing pattern provides the strongest signal when appearing at the bottom of a downtrend and indicates a surge in buying pressure.
The bullish engulfing pattern often triggers a reversal of an existing trend as more buyers enter the market and drive prices up further.
The pattern involves two candles with the second candle completely engulfing the body of the first candle.
The Bearish Engulfing pattern is simply the opposite of the Bearish Engulfing pattern. It provides the strongest signal when appearing at the top of an uptrend and indicates a surge in selling pressure.
The Bearish Engulfing pattern often triggers a reversal of an existing trend as more sellers enter the market and drive prices down further.
The pattern involves two candles with the second candle completely engulfing the body of the first candle.
Traders can look to trade engulfing patterns by waiting for confirmation of the move. This is done by observing price action after the pattern has formed and seeing if the price continues in the expected direction.
Limitations of Using Engulfing Patterns
A bullish engulfing pattern can be a powerful signal, especially when combined with the current trend; however, they are not bulletproof. Engulfing patterns are most useful following a clean downward price move as the pattern clearly shows the shift in momentum to the upside. If the price action is choppy, even if the price is rising overall, the significance of the engulfing pattern is diminished since it is a fairly common signal.
The engulfing or second candle may also be huge. This can leave a trader with a very large stop loss if they opt to trade the pattern. The potential reward from the trade may not justify the risk.
Establishing the potential reward can also be difficult with engulfing patterns, as candlesticks don’t provide a price target. Instead, traders will need to use other methods, such as indicators or trend analysis, for selecting a price target or determining when to get out of a profitable trade.