Hello there, this is tradingpedia.com and this video deals with bullish and bearish engulfing. These are Japanese candlesticks reversal patterns, and this is the reason why we have such big candlesticks on the chart.
Every trader is familiar with these patterns, but most of them are wrong because the true bullish and bearish engulfing pattern forms quite rare on the FX market and the timeframe is very important. Before searching for examples, let’s define the rules for bullish and bearish engulfing.
These is a two-candlestick pattern – one candlestick like this followed by another one. The real body of the candlesticks can be either green or red, depending on the trend’s nature, and they many have upper or lower shadows.
For instance, let’s assume that the market is in a falling trend. Then, at one point in time, it forms an aggressive candlestick that doesn’t show anything, with a very strong real body, bearish, and with an upper shadow that tells you more about the aggressiveness of the pattern. But its shape doesn’t matter.
At one moment, a new candlestick forms, that totally engulfs the previous candlesticks real body, without engulfing the upper shadow. If it does engulf the upper shadow, that is not your pattern. And this is the mistake that many traders do.
Examples of Bullish and Bearish Engulfing
Let’s have a look at some examples of bullish and bearish engulfing. We see here that the market travels to the upside in a bullish trend, and then at one point in time forms a candlestick. And then the second candlestick fully engulfs the body of the previous one, but also the lower shadow – this is not possible in such a pattern. Moreover, this pattern does not fit the “bill” if you want, because the real body of the two candlesticks are supposed to be equal and in this case the difference is quite big.
If we continue searching for examples, we see here that the market is still in a bullish trend. Suddenly, the market forms a bullish candlestick – nothing signals that a reversal pattern is in the making. Then another candlestick follows and engulfs the real body of the previous candlestick. However, it engulfs the lower shadow again and this is not a bearish engulfing pattern.
For it to be valid, the price on the second candlestick should have closed beyond the opening price of the first candlestick without engulfing the lower shadow belonging to the first candlestick in the pattern. You might say, well, these are really rare patterns – they are, but for a reason. When you find one, it is like finding a gem in technical analysis, especially if they form on the bigger timeframes because they provide risk-reward ratios that other patterns fail to do.
Here, for instance, we have a true bullish engulfing. We have a bearish trend and at one moment, at the bottom, we have a candlestick with a strong real body followed by a candlestick with a totally opposite real body that closes beyond the previous candlesticks’ opening price but without engulfing its shadow.
This is a bullish pattern, a reversal pattern that tells us that the correction ended and a new trend higher is about to start. How to trade it?
We use two horizontal lines to mark the lows and the highs in the pattern. In this case, the highs and the lows in the pattern belong to the same candlestick. That’s alright. Then we found out 50%-61.8% of the range, using a Fibonacci Retracement tool, and this is where we want to go to the long side with a stop-loss order at the loss. Why such an order? The stop is mandatory because often bears will try to take control here.
If you see a Japanese reversal pattern that fails to threaten the lows or the highs, try to ignore that pattern because usually it is a false breakout. So, this would be the risk and the reward can be projected three or four times to the upside, depending on the aggressiveness of the trader, on the available margin in the trading account, on the tactic, and so on. Some traders use 1:3 risk-reward ratios and by the time the market reaches 1:3, that should be the exit. But some others try to trail the stop, leaving a bit of a distance between the candlesticks. For example, the market keeps advancing and by the time it reaches 1:3 or so they move the stop to break-even. From that moment on that is a risk-free trade and then you look for reversal patterns or continuation pattern either to add on the trade or to book the profits.
To sum up, bullish and bearish engulfing patterns are two-candlestick patterns, the second candlestick must engulf the previous candlestick’s real body, but not the shadow. Because they are reversal patterns, they form at the end of bullish and bearish trends and to trade them, measure the high and the low in the pattern, find the 50%-61.8% retracement level, go long or short, place a stop at the top or bottom, measure the risk, project it three times from the entry place and that is the reward for a risk-reward ratio of 1:3.
But because they are such rare patterns, they provide risk-reward ratios much better than other patterns do. Bye, bye.