How The Engulfing Chart Pattern Works

Engulfing chart patterns are among the most popular and reliable reversal patterns. One of the oldest, this two-candlestick pattern can indicate that a trend has run its course and is about to reverse. The pattern is especially useful in short-term trading when used within the context of an intermediate trend or countermove. In this post, we'll take a look at how to identify an engulfing chart pattern, what factors you need to consider before taking a trade, and how to manage your trade once you're in.

Engulfing chart patterns occur when the body of the second candlestick completely "engulfs" the body of the first candlestick. The first candlestick in the pattern should be small, with a long wick to the upside (if it's a bullish engulfing pattern) or a long wick to the downside (if it's a bearish engulfing pattern). The second candlestick should be much larger than the first, with small wicks on either side. It should be noted that, based on my 20 years of experience in the markets, the wick requirements are traditional, but not absolutely necessary.

The critical thing to note about an engulfing chart pattern is that it has the most predictive power if it occurs at a significant support or resistance level, i.e., the context in which it occurs is important. For example, if you see a bearish engulfing pattern on a chart right after an extended uptrend, it's more likely that prices will fall. However, if you see a bearish engulfing pattern on a chart that doesn't appear to be at any particular support or resistance level, it's less likely that prices will actually reverse lower.

Weekly Chart for Wk Ended 16 September 2022; Bearish Engulfing pattern against resistance at TAOST Weekly Channel... Looks like more downside to come.

When considering taking a trade based on an engulfing chart pattern, you must make sure to wait for confirmation before entering. One way to get confirmation is to wait for the price to break below the lows of the candlesticks in the pattern; another way is to use a moving average crossover as your trigger; finally, it's always my preferred option to drop down to a lower timeframe and take a confirming trade set up in the direction of the context established by the higher timeframe engulfing chart pattern. However you enter, once you're in a trade, your ultimate stop loss [where your opinion changes] should be placed just beyond the opposing extreme of the 2 candlestick pattern.

Take This With You

Engulfing chart patterns can be extremely useful in identifying potential reversals in both uptrends and downtrends. Before taking any trades based on this pattern, make sure to wait for confirmation and always place your ultimate stop loss just above (for bearish engulfing patterns) or below (for bullish engulfing patterns) the highs/lows of the pattern—this will help you stay in winning trades and avoid getting burned by false signals.