Engulfing Candlestick Patterns Explained: What They Are & How To Trade Them

What Is an Engulfing Candlestick Pattern?

An engulfing candlestick pattern is a 2-candlestick formation that may signal a reversal.  It is made up of one candle moving in the direction of current trend followed by a second candle that opens and closes above and below that of the first candle, or vice versa.

The engulfing candlestick pattern has both bullish and bearish variations.  Either way, the engulfing candle essentially functions as the potential breaking point of prior trend.

Of course, no candlestick pattern guarantees a particular outcome.  Instead, they offer clues as to what is going on in the market.

So the question is, what does an engulfing candlestick really tell you?

What Engulfing Candlesticks Patterns Mean

Unlike the vast majority of candlestick patterns, the name describes it very well.

And unlike some, English speakers do not use the Japanese name.  It is named for the way the second candlestick seems to consume the first one (and perhaps the trend’s momentum along with it).

In trading terms:

• During the first period, price continued the ongoing trend.
• The second period opens with a gap in the direction of trend that is quickly filled as price proceeds to reclaim all the ground from the first day and then some, closing outside the open and close of the previous candle.

This sets the stage for reversal, as counter-trend pressure is beginning to bubble over.

How To Recognize Engulfing Candlestick Patterns

Traders are attracted to patterns partly because they are easy to spot.

However, it’s also easy to see things on the charts that aren’t truly there (or anticipate events that never come to fruition).  That’s one of the reasons why waiting for confirmation is so important.

Technically, an engulfing candle pattern must:

• Begin with a candle moving in the direction of trend
• End with a candle of greater size moving against trend
• Have the first candle’s body contained completely within the body of the second

In practicality though, many traders will make various exceptions.

• The first candle can be a neutral candle (ie. a doji), as long as it is fully contained within the body of the second.
• The first candle can move against trend, as long as it is fully contained within the body of the second.
• The open of the second candle can be even with the close of the first candle, especially in markets where gaps are less common like cryptocurrency.

Depending on who you ask, any of these standards may be more or less important.  Moreover, some of these variations may be more properly classified as other reversal candlestick patterns.

Remember, identifying the reversal itself is more important than labeling the formation.  That’s not to say these standards are completely unimportant (as we’ll touch on shortly).  It’s just to say that the implications are more important than the criteria.

In other words, you need to put it into context.

Where Engulfing Candlesticks Fit in the Chart Narrative

The markets are often characterized as a battle between the bulls and the bears.

Engulfing candlestick patterns show that the momentum fizzled out on candle one, demonstrated by a counter-trend move on candle two.

On the chart, it looks like the dam broke.

It might happen like this on a daily time frame:

After a strongly trending day, traders awoke the next day to a price gap in the same direction as trend.  However, that gap was immediately filled as price suddenly reversed.  Once it broke through the prior day’s close, it was like the floodgates opened.  Price action rapidly erased the movement of the day before, eventually closing beyond its opening.

In the short-term, it amounts to a counterpunch.

The question traders need to ask themselves is, “Will this lead to sustained reversal or will it fizzle out quickly?”

To answer that question, you’ll need more than just an understanding of Japanese candlesticks and candlestick patterns.  You’ll want to analyze both within the context of greater chart patterns as well as trend and price levels.  You’ll also want to make use of your own chart markup and indicators.

Analyze the history of your preferred asset(s) with respect to engulfing candlestick patterns and apply it to your own trading style.

Now, you can test (and/or stretch) the criteria we mentioned above to find the most tradeable opportunities.  For example, you may find that engulfing candlesticks whose second candle encompasses the body and wicks play out more reliably than those that only encompass the body.  Or, you may find the opposite.

Here is where the story in the charts begins to come into focus.

This is what we call technical analysis.

How To Trade Engulfing Candlesticks Patterns

Reversal points are great places to enter or exit trades.

Engulfing candlestick patterns serve as easy-to-spot signs of potential reversals—and may even lead to longer-term tops or bottoms when found on higher time frames.

Generally, you can put more weight into multi-stick patterns than single candles.  They give you more information over a longer amount of time.  Still, it is considered unwise to trade based on candlestick patterns alone.  They rarely have extremely high hit rates by themselves.

You need additional points of confluence to shift the probabilities in your favor.

Some of the more important ones include:

• Volume – Reversals are often accompanied by elevated trading volume.  For engulfing patterns, be on the lookout for it on the second candlestick.
• Price Formations – Reversal patterns like engulfing candles often form near important price levels or trend lines, leading to a bounce at support or rejection at resistance.
• Oscillator Shift – Oscillating indicators like the RSI or stochastics are commonly used to identify reversals by analyzing slope, percentile, and/or divergence.

The fewer such factors corroborating the reversal, the less confident you can be about it.

It would be difficult to form a comprehensive trading strategy around engulfing candlestick patterns.  There simply isn’t enough there to develop a strong edge.  Even with a great understanding of trading math, orders, psychology, risk management, options, and automation, you’d still have a hard time.

You’re much better off building your strategy around other tools then using reversal patterns as an additional point of confirmation.

Patterns like the engulfing are much better idea givers than trade makers.

Other Candlestick Pattern Types

The engulfing candlestick is but one of many candlestick patterns.

You’d be wise to get familiar with all of the other ones too.

• Abandoned Baby
• Breakaway
• Counterattack Lines
• Doji Star
• Harami
• Harami Cross
• In Neck
• Kicking
• Ladder
• Last Engulfing
• Mat Hold
• Matching
• Meeting Lines
• On Neck
• Separating Lines
• Star
• Stomach
• Tasuki Gap
• Three Inside
• Three Methods
• Three Outside
• Tweezer
• Window

Sure, there are quite a few of them.  But don’t let that intimidate you.

It’s unnecessary to memorize all the names and criteria for every pattern.  What’s more important is to learn the principles of price action and technical analysis.

In fact, you’re free to forget all of the names and specifications as long as you can look at a group of candlesticks and understand what they are trying to tell you.

Takeaways

To review:

Engulfing candlesticks are a type of candlestick pattern that signals a potential reversal.  While not a guarantee, their appearance may indicate that market conditions are changing.  Thus, they can help you find winning trades.

Of course, there are other candlestick patterns that you should learn about.  And even so, the ability to recognize patterns is not enough to trade successfully on its own.

Nonetheless, you’ve now added one more tool to your toolkit.

Have questions or more information to add?  Contribute to the conversation in the comments below!  Or, if you know someone who could benefit from this post, share it with them.  You can also check out our Candlestick Patterns Guide to improve your candlestick analysis skills.