Two Candle Patterns

What is a bullish engulfing candle？

The bullish engulfing candle appears at the bottom of a downtrend and indicates a surge in buying pressure. The bullish engulfing pattern often triggers a reversal in trend as more buyers enter the market to drive prices up further. The pattern involves two candles with the second candle completely engulfing the body of the previous red candle.

The image below depicts the bullish engulfing pattern appearing at the bottom of a downtrend.

The following image focuses on the bearish and bullish candles that constitute the bullish engulfing pattern.

How to spot a bullish engulfing pattern and what does it mean？

Characteristics of a bullish engulfing pattern:

• A strong green candle that ‘engulfs’ the prior red candle body (disregard the wicks)
• Occurs at the bottom of a downward trend
• Stronger signals are provided when the red candle is a doji, or when subsequent candles close above the high of the bullish candle.

What does it tell traders？

• Trend reversal to the upside (bullish reversal)
• Selling pressure losing momentum at this key level.

Advantages of trading with the bullish engulfing candle:

• Easy to identify
• Attractive entry levels can be obtained after receiving confirmation of the bullish reversal.

Know the difference between a bullish and a bearish engulfing pattern

Engulfing patterns can be bullish and bearish. The bearish engulfing pattern is essentially the opposite of the bullish engulfing pattern discussed above. Instead of appearing in a downtrend, it appears at the top of an uptrend and presents traders with a signal to go short. It is characterized by a green candle being engulfed by a larger red candle.

Bearish Engulfing Pattern

Below is a summary of the main differences between the bullish and bearish engulfing patterns. Traders should keep these in mind in order to avoid false signals.

Using a Bullish Engulfing Candlestick Pattern in Trading

Bullish engulfing and forex trading

The bullish engulfing candle pattern can be observed in action in the GBP/USD daily chart presented below. Here, the pattern is shown in a downtrend. Subsequent candles validated the signal as they closed above the high of the bullish candle. Stops can be set below the low of the bullish engulfing pattern with a target set at a key level that price has bounced off previously – this is the recent swing high and provides a positive risk-to-reward ratio.

Bullish engulfing and stock trading

Not only is the Bullish engulfing a popular strategy in forex, but it can also be applied to the stock market. A bullish engulfing trading strategy is provided below on Fedex Corp [FDE], listed on the NYSE

The key to building confidence when trading the bullish engulfing candle is to complement the candle formation with a supporting signal/indicator.

The chart below shows the presence of a Dragonfly Doji Just before the engulfing pattern - signaling the rejection of lower prices. This fits the bullish bias along with the oversold signal on the RSI at the bottom of the chart. These supporting signals provide tock traders with greater conviction before executing the trade.

The stop loss can be placed below the recent swing low - which is the low of the Dragonfly Doji. The target (limit) can be placed at a key level that the price has bounced off previously, provided it results in a positive risk-to-reward ratio.

What is a Bearish Engulfing Pattern？

A bearish engulfing pattern produces the strongest signal when it appears at the end of an uptrend. The pattern is created by interpreting the data of two completed candles:

The first candle will depict the end of the established trend strength. It should be noted the size of this primary/bullish candle can vary but it is crucial that the body of this candle gets completely ‘engulfed’ by the candle that follows. Dojis and other small bullish candles provide the strongest signal as they can reflect market indecision in the current trend.

The second candle in the pattern is the reversal signal. This candle is comprised of a long red candle creating fresh downward price momentum. This bearish candle should open above the close of the previous candle and close well below the low of the previous candle. This strong downward movement reflects sellers overtaking buying strength and often precedes a continued fall in price. The further this secondary/ bearish candle declines, the stronger the signal becomes.

Know the Difference between a Bearish Engulfing Pattern and a Bullish Engulfing Pattern

Engulfing patterns can be bullish and bearish. The bullish engulfing pattern is essentially the opposite of the bearish engulfing pattern discussed above. Instead of appearing in an uptrend, it appears at the bottom of a downtrend and presents traders with a signal to go long. It is characterized by a red candle being engulfed by a larger green candle.

Bullish Engulfing Pattern

Using a Bearish Engulfing Candle in Trading

Traders should always be on the lookout for trade confirmation by utilizing indicators, key levels of support and resistance, or any other technique that will support or invalidate a trade. Presented below are two approaches that traders can use to strengthen the bearish bias suggested by the bearish engulfing pattern.

Trading the Bearish Engulfing Candle Using Indicators

The example below highlights the bearish engulfing pattern appearing at the top of the uptrend on the EUR/USD daily chart. While it is not advisable to trade against the trend, in reality, reversals do occur, which is why all traders should be able to spot when this is likely to appear.

The chart shows the Euro appreciating and topping out at where the bearish engulfing pattern appears. Additionally, the Relative Strength Indicator (circled in black) validates the bearish bias with an ‘overbought’ signal.

Taking a closer look at the chart, entry levels, stops, and targets can be identified.

Entry: Traders can wait for a close lower than the low of the bearish candle or simply place working orders far below the low.

Stop loss: A stop can be placed above the recent swing high as this would invalidate the move and provide a sensible risk-to-reward ratio.

Target/Take profit: Since bearish engulfing candles can indicate the beginning of a prolonged downtrend, it is helpful to consider an initial take profit level while remaining open to further downward movement. Adjust stops accordingly or consider using a trailing stop.

Trading the Bearish Engulfing Candle Using Support & Resistance

The chart below shows a bearish engulfing candle pattern appearing at resistance on the US Dollar Index (DXY). The level of support is important here because it shows that higher movements have been rejected previously. When the bearing engulfing pattern appears at resistance, it provides greater conviction towards a bearish bias.

Entry: Considering the bearish engulfing is backed up by the level of resistance, traders may consider entering the trade at the open of the following candle.

Stop: The stop can be placed above the bearish engulfing candle and the level of resistance. A move above this would invalidate the move.

Target/Take profit: Targets can be set at a recent level of support. For the same reason as the above example, traders may consider a second target level - or implement a trailing stop - as the bearish engulfing candle may signal the start of a sustained downtrend.