The Engulfing Pattern

Bullish Engulfing Pattern

There are 3 criteria for bullish engulfing pattern:-

1. The market has to be in a clearly definable downtrend for a bullish engulfing pattern, even if the trend is short term.
2. Two candles comprise the engulfing pattern. The second real body must engulf the prior real body (It need not engulf the shadow).
3. The second real body of the engulfing pattern should be the opposite color of the first real body. (The exception to this rule is if the first real body of the engulfing pattern is a doji. Thus, after an extended fall, a doji engulf by a very large green real body could be a bottom reversal).

   

Most candle signals, however, are based on combination of individual candle stick. The engulfing pattern is the first of these multiple candle stick patterns. The engulfing pattern is a major reversal signal with 2 opposite color real body's composing this pattern. 

    

This image shows a bullish engulfing pattern. The market is falling. Than a green bullish real body wraps around, or engulfs the prior period's red real body (Hence its name). This shows buying pressure has overwhelmed selling pressure. 

How to Trade? 

Some factors increasing the likelihood than an engulfing pattern could be an important turning signal are:-

1. If the first day of the engulfing pattern has a very small real body and the second day has a very long real body. The small first real body candle reflects a dissipation of the prior trend's force and the large second real body proves an increase in force behind the new move.
2. If the engulfing pattern appears after a protected or very fast move. A fast or extended move create an over extended market & makes it vulnerable to profit taking.
3. If there is heavy volume on the second real body of the engulfing pattern.

A prime use of the engulfing pattern is utilizing them as support or resistance. By the time a bullish engulfing pattern is completed (Remember, we need to wait for the close of the second session before we know its a bullish engulfing pattern), the market maybe well off its lows. As such, i would feel that it has gotten away from an attractive buying area. In such a scenario, we can wait for a possible correction to our support area at the lows of the bullish engulfing pattern and than consider stepping in from the long side.

Bearish Engulfing Pattern

There are 3 criteria for bullish engulfing pattern:-

1. The market has to be in a clearly definable uptrend for a bearish engulfing pattern, even if the trend is short term.
2. Two candles comprise the engulfing pattern. The second real body must engulf the prior real body (It need not engulf the shadow).
3. The second real body of the engulfing pattern should be the opposite color of the first real body. 

 The bearish engulfing pattern can be important because it shows sellers have overtaken the buyers and are pushing the price more aggressively down than the buyers were able to push it up. A bearish engulfing pattern can occur any where, but it is more significant if it occurs after an advance, this could be an uptrend or a pullback to the upside with a larger down trend. 

Before acting on the pattern, traders typically wait for the second candle to close.