Since candlesticks are the basic building block of most technical analysis, the ability to read the patterns they make is a valuable trading skill. Here, we’ll go over everything you need to know to make money with last engulfing candlestick patterns.
First though, let’s start with a definition.
What Is a Last Engulfing Candlestick Pattern?
A last engulfing pattern is a 2-candlestick formation that may signal a continuation. It consists of a large candle moving against the current trend followed by a large candle moving with the trend that is preceded by a gap and closes beyond the open of the first.
***Please note, many sources list the last engulfing as a reversal pattern. However, various quantitative analyses show that it actually acts as a continuation pattern, which matches the way the pattern looks.
The last engulfing pattern has both bearish and bullish versions, known respectively as the last engulfing top and last engulfing bottom patterns. It is a variation of the engulfing pattern and therefore related to the three outside pattern. For all of these, the final candle indicates their directional biases.
Of course, candlestick patterns do not guarantee specific outcomes. Instead, they offer clues as to what is going on in the market.
So the question is, what do last engulfing candlesticks really tell you?
What Last Engulfing Patterns Mean
The names last engulfing top and last engulfing bottom are a bit of an issue.
The “engulfing” part fits, as you could describe the second candlestick as consuming the first one. However, the “top” and “bottom” parts imply reversals. In reality, they function more like continuation signals. This makes their names fairly misleading. Consequently, it may be a smart idea to treat all engulfing candles as directional signals instead of reversal or continuation signals.
In trading terms:
- During the first period, price drove strongly in the opposite direction of the trend.
- Before the second period began, price moved further in the opposite direction of the trend.
- During the second period, price drove strongly in the direction of the trend and closed beyond the open of the first period.
This sets the stage for continuation, as trend-side traders appear to have swallowed the counter-rally whole.
How To Recognize Last Engulfing Candlestick Patterns
Traders are attracted to patterns partly because they stand out.
However, it’s easy to see things on the charts that aren’t truly there (or anticipate events that never come to fruition). That’s the main reason you should wait for all candles to close before making decisions based on candlestick patterns.
In theory, a last engulfing pattern must:
- Begin with a long candle moving against pre-existing trend.
- End with a long candle that 1) opens with a gap against trend, 2) moves with trend, and 3) closes beyond the body of the first.
In practicality, many traders will make some 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 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.
- The second candle doesn’t necessarily have to be a long candle, as long as it fully contains the body and wicks of the first.
Depending on who you ask, any of these standards may be more or less important. Technically, it would be more accurate to classify some of these variants as a different candlestick continuation pattern or none at all.
This is okay, as the implication means more than the classification. And similar patterns tend to have similar implications.
That’s not to say that these standards are altogether inconsequential (as we’ll elaborate on soon). You should definitely consider some non-negotiable, like the direction of the candles in relation to trend or where the second candle closes. Just keep in mind that context trumps criteria.
Ultimately, it’s up to you to decide how seriously to take each guideline.
After all, the goal of candlestick pattern analysis is to interpret underlying price action (not just label patterns correctly).
To this end, you need to understand where they fit.
Where Last Engulfing Candlesticks Fit in the Chart Narrative
The markets are often characterized as a battle between the bulls and the bears.
Last engulfing patterns show that those trading against trend attempted to take control on candle one (and between candles one and two) but completely surrendered the momentum back by the end of candle two.
On the chart, it looks like an easily thwarted top or bottom attempt.
The first day saw a powerful move against the trend, to the surprise of many. Then, traders awoke the next morning to a gapped open. This led to a flurry of trading activity as both sides saw opportunity. Ultimately, trend-side pressure was simply too great to overcome. By final bell on the second day, price moved all the way back beyond the open of the first day.
Over the coming days, the levels set by these candles are likely to become crucial decision zones. If those looking for continuation can defend this price level, they have a better chance at keeping the trend on their side.
(This is only a hypothetical illustration, as a last engulfing pattern could represent a number of real-world scenarios.)
In the short-term, it amounts to a failed coup.
The question traders need to ask themselves is,
“Is continuation imminent or will there be another attempt to stem the tide?”
To answer that question, you’ll need more than just an understanding of Japanese candlesticks and candlestick patterns. You’ll want to evaluate both within the context of longer-term chart patterns as well as trend and price levels. You’ll also want to make use of your own chart markup and indicators.
Explore the history of your preferred asset(s) with respect to last engulfing patterns and apply your findings to your own trading style.
Now, you can test (and/or stretch) the criteria we mentioned earlier to identify the best trade setups. For instance, you may find that last engulfing candles in which the second candle’s body fully contains the wicks of the first perform more reliably than those in which the second candle’s body only contains the body of the first. Or, you may find something else entirely.
This is the kind of technical analysis that brings the story in the charts into full focus.
How To Trade Last Engulfing Patterns
Continuation points are great places to add to your position or adjust your stop loss.
Last engulfing candlestick patterns serve as easy-to-spot signs of potential continuation and may even lead to the next big leg up or leg down. Generally, you can assign greater weight to multi-stick patterns than single candles because they give you more information over a longer duration.
However, there are a few things you should know about trading candlestick patterns.
First and foremost, their hit rates rarely exceed 70%. According to Bulkowski’s Encyclopedia of Candlestick Patterns, if you treat them as continuation signals, last engulfing tops have a 68% hit rate and last engulfing bottoms have a 65% hit rate. Although these numbers are pretty good compared to most candlestick patterns, they are far from a “sure thing.”
In addition, candlestick patterns do not have standardized price targets or measured moves like chart patterns do. This can make it difficult to decide when to exit your trade or how to manage your position.
Moreover, failed continuation patterns often lead to reversal or consolidation. Therefore, you need additional points of confirmation to increase your odds of success.
Some such factors include:
- Volume – For continuation, you typically want to see reduced trading volume against the trend. That means low volume on the first candle of a last engulfing may be a good omen.
- Price Formations – Continuation patterns like the last engulfing tend to perform better when there is thin support or resistance in their way. If it’s a blue sky breakout, even better.
- Matching Momentum – Oscillating indicators like the RSI or stochastics are commonly used to identify continuation by analyzing slope, percentile, and/or divergence.
The more corroborating elements are present, the more confident you can be about a last engulfing continuation signal.
Even so, it would be difficult to form a successful trading strategy around any given candlestick pattern. There simply isn’t enough there to develop a strong edge. Even with a great understanding of trading math, order execution, market psychology, risk management, options, and automation, you’d still have a hard time.
In essence, last engulfing patterns are much better idea givers than trade makers.
Better yet, you’ll probably find more success building your strategy around other tools then using candlestick patterns as the final point of confirmation.
Other Candlestick Pattern Types
The last engulfing is but one of many candlestick patterns.
And while learning them all is not a prerequisite for successful trading, you’d certainly benefit from getting familiar with other candlestick pattern types.
They can be categorized in several ways.
The most straightforward way may be by the number of candlesticks (ie. 2-candlestick, 3-candlestick, 5-candlestick, etc.)
More helpful though, you can group them by price direction or signal type. That is, they can be bullish or bearish and/or imply continuation or reversal. Finally, you can multiply these designations together to separate them into bullish continuation, bearish continuation, bullish reversal, and bearish reversal categories.
On the other hand, you might just tackle them in alphabetical order:
- Abandoned Baby
- Breakaway
- Counterattack Lines
- Doji Star
- Engulfing
- Harami
- Harami Cross
- In Neck
- Kicking
- Ladder
- Mat Hold
- Matching
- Meeting Lines
- On Neck
- Separating Lines
- Star
- Stomach
- Tasuki Gap
- Three Inside
- Three Methods
- Three Outside
- Three-Line Strike
- Tri-Star
- Tweezer
- Window
Sure, there are quite a few. But don’t let that intimidate you.
It’s unnecessary to memorize the name and criteria of every single pattern. The key is to learn the principles of price action and technical analysis.
In fact, you’re free to forget all of their names and specifications as long as you can look at a group of candlesticks and understand what they are trying to tell you. It’s just that the more of them you learn about, the easier this will become.
So take the time to study at least a few more of them.
Takeaways
To review:
Last engulfing candlesticks are a type of pattern that signal a potential continuation. While not a guarantee, their appearance may indicate that market conditions are likely to remain the same. Thus, they can help you find winning trades.
Of course, there are other candlestick patterns that you should learn about. Still, 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.