But before we start on the topic, let’s have an overview on candlestick charts.
Candlesticks have a “body”, which is made up of the difference between the open and close of the session. Naturally, the higher values create the upper end of the body, and lower values make up the lower extreme.
These candles have “wicks”, which are also called “tails” and “shadows”. These lines indicate what the highest and lowest values the stock had hit for the session. The upper shadow would be the high of the session, and the lower shadow would be the amount the stock lost.
Green/white and red/black candlesticks have opposite open and close prices of the stock; if the candle is green or white (bullish), the lower extreme would represent the opening price and would mean that the stock’s price climbed during the period being charted. However, with red or black candles (bearish), the lower extreme would be the closing price, and indicates the stock fell during the said period.
There are over a hundred individual candlesticks and patterns under them. But for today, we’ll discuss one of the popular patterns: the engulfing candles.
Identifying Engulfing Candles Patterns
The engulfing candlestick pattern is one of the easiest of candlestick reversal patterns to identify. Because these patterns take two candlesticks to be identified, they are more valid and are often viewed as reversal patterns. The bullish or bearish engulfing pattern takes more priority depending on the time frame that they are charted on.
When looking to trade with the engulfing candlestick pattern, it is vital to initially examine the charts from monthly, weekly, and daily, and then to the lower time frames. Usually, the accuracy of this setup is predominantly potent on hourly charts and higher time frames.
Spotting and distinguishing bullish and bearish patterns are quite easy:
· Bullish Engulfing setup: A bearish candle is followed by a bullish one; as if the bullish one “engulfs” the previous.
· Bearish Engulfing setup: The second candle’s body completely engulfs or covers the range of the first candle’s body.
While there is no specific size requirement, normally both bars in the pattern should be substantial that they show a strong short-term shift in momentum. Both candles must also have short wicks, with a total length of no more than 33% of the entire candle’s length.
Trading Engulfing Candle Patterns
The first step is to identify the engulfing pattern within the context on the trend prior and not in isolation, and keep in mind of the main prevailing sentiment or the major trend.
Depending on the price action, price could either begin a new trend in the opposite direction or merely head towards making a correction to the previous trend. Using the trend and the engulfing candle as a trade trigger makes for a powerful combination. This technical analysis strategy works well on any chart and market—as long as the market has substantial volume.
Here we have an example of the GBP/USD daily chart, showing two bullish engulfing patterns. At the moment, it is continuing an upward trend from the engulfing pattern setup that started on August 31. The upwards trend began with the strong bullish engulfing candle completed on August 16, as indicated by the first arrow.
Along the way there have been price retracements against this mature trend, but most of these declines have ended in a bullish engulfing candle. These price upsurges have established the continuation of the broader trend, while generating new buying opportunities.
The current GBP/USD candle will be monitored by traders if it will continue its bull trend in the next session. If the price does remain buoyed, traders should take this as a bullish market signal and look for the pair to climb higher.
Also keep in mind that if a bullish candle is engulfed by a bearish one, the higher-probability direction to trade the pair will be short. If a bearish candle is engulfed by a bullish candle instead, then the higher-probability direction to trade would be long.
In the case when interpreting candlesticks, a trader should not make a decision regarding what a candle might turn out to be until that candle is closed.
Another tip is to only take a trade when the candle indicates a potential direction alteration when the change is in the direction of the trend. To put simply: in a downtrend, look for bearish engulfing candles and vice versa. Should the trade be taken, the stop would be placed below the bullish engulfing candle in an uptrend and above the bearish engulfing candle in a downtrend.
Take note that there are many engulfing candles on the chart where a move in the opposite direction did not take place after the engulfing candle closed. After all, nothing in the trading industry is certain. Take caution!
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