Candlestick patterns are vital tools in technical analysis, offering traders insights into market sentiment and potential future price movements. Among these patterns, the engulfing candle stands out as one of the most powerful indicators of potential reversals. Whether you’re dealing with cryptocurrency, stocks or forex, understanding the engulfing candle can provide you with a significant edge in your trading strategy.

The engulfing candle pattern is simple yet effective. It consists of two candles, where the second candle fully engulfs the body of the first one. This pattern can appear in two forms: the bullish engulfing candle and the bearish engulfing candle. Both signal a potential reversal of the current trend, making them essential tools for traders aiming to enter or exit the market at optimal points.

Why is it Called an Engulfing Candle?

To understand why this pattern is called an "engulfing" candle, imagine standing on the beach, watching the waves. A small wave comes in, barely making an impact on the shore. But then, a much larger wave follows, completely overtaking the smaller one, sweeping everything in its path. This is akin to what happens in the market with an engulfing candle pattern.

In trading, the first candle represents the small wave. It shows the market’s initial sentiment—whether bullish or bearish. However, the second candle, like the larger wave, completely overtakes or engulfs the first one. This second candle represents a strong shift in market sentiment, overwhelming the previous direction and signaling a potential reversal.

The word "engulfing" is used because the body of the second candle completely engulfs the body of the first candle, showing that the new market force (whether buyers or sellers) has taken full control. This visual dominance on the chart is what makes the engulfing candle such a powerful signal for traders. Below is an illustrated engulfing formation.

What is an Engulfing Candle?

An engulfing candle is a two-candle pattern that signals a potential reversal in the market’s current trend. It occurs when the body of the second candle completely engulfs the body of the first candle, showing a strong shift in market sentiment. This pattern can be either bullish or bearish, depending on where it forms in relation to the ongoing trend.

What is a Bullish Engulfing Candle

This pattern typically appears at the end of a downtrend. It begins with a small bearish candle, indicating that sellers were in control. However, the next candle is a large bullish one that completely engulfs the previous bearish candle, signaling that buyers have taken over and a reversal to the upside may be imminent.

What is a Bearish Engulfing Candle?

Conversely, this pattern is usually found at the top of an uptrend. It starts with a small bullish candle, showing that buyers were initially in control. The second candle is a large bearish one that engulfs the first, suggesting that sellers have overwhelmed the buyers and a downward reversal might occur.

These patterns are powerful because they visually represent the battle between buyers and sellers. The engulfing candle's ability to overtake the preceding candle signals a clear shift in control, making it a reliable indicator for traders looking to capitalize on market reversals.

Engulfing vs. Harami candlestick patterns

While both engulfing and Harami patterns involve two candles and are used to identify potential trend reversals, they differ in formation. In an engulfing pattern, the second candle completely engulfs the body of the first, indicating a stronger shift in market sentiment. Conversely, a Harami pattern occurs when the second candle is completely contained within the body of the first candle, signaling indecision and a possible, but less certain, reversal.

Why are Engulfing Candles Important?

The Significance of Engulfing Candles in Trading

Engulfing candles hold a special place in technical analysis because they provide clear and strong signals of potential trend reversals. Understanding their significance can help traders make better-informed decisions, whether they are looking to enter or exit positions.

Clear Reversal Signals: One of the primary reasons engulfing candles are important is that they offer clear reversal signals. A bullish engulfing candle indicates that the buyers have taken control after a period of selling pressure, suggesting that the price may start moving upwards. On the other hand, a bearish engulfing candle shows that sellers have overtaken the buyers' momentum, signaling a possible decline in price.
Reliable Indicator of Market Sentiment: Engulfing patterns are also valuable because they reflect a significant shift in market sentiment. The fact that the second candle completely engulfs the first suggests a decisive change in who holds the upper hand in the market—whether it's the bulls or the bears. This visual representation of market psychology makes engulfing candles a reliable tool for predicting future price movements.
Flexibility Across Markets: Engulfing candle patterns can be used across different markets, including cryptocurrencies, stocks, and forex. Their appearance on various time frames—from intraday to weekly charts—adds to their versatility, making them useful for different types of traders, whether short-term or long-term.

How to Trade Using Engulfing Candles on CoinEx

Identifying Engulfing Patterns on Different Time Frames

When trading on CoinEx, selecting the right time frame is crucial for identifying and acting on engulfing candle patterns effectively. Different time frames serve different trading strategies, whether you're a day trader looking for quick opportunities or a long-term trader focusing on larger market trends. Here’s a table that summarizes typical time frames and their use cases for trading engulfing patterns:

Entry and Exit Strategies

To trade engulfing patterns on CoinEx effectively, it’s important to confirm the pattern before entering a trade. For a bullish engulfing pattern, wait for the third candle to close above the engulfing candle to confirm that the trend is reversing. At this point, you could place a buy order. Conversely, for a bearish engulfing pattern, wait for the confirmation candle to close below the engulfing candle before entering a sell position. This strategy helps minimize the risk of false signals and ensures you are entering trades with a higher probability of success.

FAQ

How to Trade with Engulfing Candles?

To trade with engulfing candles, identify the pattern on a relevant time frame and confirm the signal with the next candle. Use additional technical indicators like SMA/EMA, VWAP, or Bollinger Bands to increase the reliability of the signal. Combine these patterns with support and resistance levels for even stronger trade signals. Setting stop-loss orders just above or below the engulfing candle helps manage risk.

Do Traders Actually Use Patterns to Trade?

Yes, traders use candlestick patterns like engulfing candles to make trading decisions, but they don’t rely on them alone. These patterns are most effective when combined with other technical indicators, such as moving averages (SMA/EMA), VWAP, Bollinger Bands, and key support and resistance levels. The more these factors align, the higher the confidence in the trade's direction.

Which Trading Strategy Makes the Most Money?

The profitability of a trading strategy can vary widely depending on the trader’s skill, market conditions, and the strategy's complexity. However, studies suggest that strategies combining multiple technical indicators and price action, like mean reversion or trend-following strategies, often yield consistent results. The key is not the strategy itself but how well it is executed and adapted to different market conditions.

Mastering the Engulfing Candle: A Novice Trader's Guide to Reversals