The engulfing candle trading strategy is one of my favorites. It’s
easy to spot and provides a way to enter a trend. Many traders use the
engulfing candle to signal the end of a trend, but here we are going to
use it to enter a trend at an opportune time. Using the trend and the
engulfing candle as a trade trigger provide a powerful combination.
Candle stick charts have become a staple for most traders, and nearly every trading platform offers this highly visual chart style. Whether it is better than other chart forms I leave up to you. It isn’t necessary to use candle sticks to trade the strategy, OHLC charts also work.
I use this strategy for day trading, although it can be applied to other time frames as well, and to various markets such as the stock market.
Engulfing Candle
There are two types of engulfing candles, a bullish engulfing candle and a bearish engulfing candle.
A bullish engulfing candle occurs when the “fat” part of an Up candle completely envelopes a prior Down candle. The fat part of the candle marks the distance between the open and close of that bar, while the “wicks” mark the high and low. While there is no specific size requirement, typically both bars in the pattern should be substantial, with the up bar showing a strong short-term shift in momentum.
Figure 1 shows an example of a bullish engulfing pattern in the AUDUSD.
On my charts, up candles are green–the close is higher than the open. Down candles are red–the close of the candle is lower than the open of the candle.
Figure 1. Bullish Engulfing Pattern: AUDUSD 1-Hour Chart
Figure 2. Bearish Engulfing Pattern: EURUSD 5-Minute Chart
If you look back at figure 1 you’ll notice that right before the bullish engulfing candle pattern, there was a bearish engulfing pattern as well. Engulfing candles occur quite often, which is why we need to some sort of other filter to trade them. I opt to use the trend.
Forex Engulfing Candle Trading Strategy
Engulfing candles occur often. While its appearance signifies a sharp short-term change in direction, many of these patterns aren’t of concern. In a trend there impulse waves and corrective waves. Ideally we want to enter on corrective waves, or pullbacks, and then “ride” the impulse for a profit.
The engulfing candle provides us a signal that a pullback is over, and the trend is about to resume. In the case of an uptrend, the bullish engulfing pattern signals that the selling which occurs on a pullback is over, and the buying is resuming. The trend doesn’t always resume right away, we may simply get a small push in the trending direction before the pullback resumes. Losing trades occur, and that is OK, as all losing trades can’t be avoided. Experienced traders can actively manage trades when this occurs, making a small profit or small loss. Alternatively, simply let the price hit your stop or target (discussed shortly) and let the odds of the trade, and having a larger potential profit than risk, work in your favor.
Figure 3. Bullish Engulfing Candle Trading Strategy in Uptrend
The goal of the strategy is to isolate a trend, and then use engulfing patterns to signal the pullback is ending and the trend is resuming. Not every pullback ends with an engulfing pattern though, sometimes we can use multiple bars to signal the end of a pullback (see video mentioned above).There is no need to wait for the engulfing candle to complete. Once it has engulfed the prior candle, take the trade. Engulfing patterns don’t have a specific profit target, therefore using a Fibonacci extensions or a fixed reward to risk ratio. Stops are placed above the high of a bearish engulfing pattern, or below the low of a bullish engulfing pattern.
If trading on a 1 or 5 minute chart, trying using an ECN forex broker with a near zero spread. Here’s the ECN broker I use (they also have normal accounts).With an ECN broker you can more efficiently exploit intra-day opportunities, since you aren’t concerned about the spread.
Candle stick charts have become a staple for most traders, and nearly every trading platform offers this highly visual chart style. Whether it is better than other chart forms I leave up to you. It isn’t necessary to use candle sticks to trade the strategy, OHLC charts also work.
I use this strategy for day trading, although it can be applied to other time frames as well, and to various markets such as the stock market.
Engulfing Candle
There are two types of engulfing candles, a bullish engulfing candle and a bearish engulfing candle.
A bullish engulfing candle occurs when the “fat” part of an Up candle completely envelopes a prior Down candle. The fat part of the candle marks the distance between the open and close of that bar, while the “wicks” mark the high and low. While there is no specific size requirement, typically both bars in the pattern should be substantial, with the up bar showing a strong short-term shift in momentum.
Figure 1 shows an example of a bullish engulfing pattern in the AUDUSD.
On my charts, up candles are green–the close is higher than the open. Down candles are red–the close of the candle is lower than the open of the candle.
Figure 1. Bullish Engulfing Pattern: AUDUSD 1-Hour Chart
Get a current short, medium and long-term analysis of the AUDUSD free…instantly: AUDUSD Trend Analysis
A bearish engulfing candle occurs when the “fat” part of a Down
candle completely envelopes a prior Up candle. Figure 2 shows an example
of a bearish engulfing pattern in the EURUSD.Figure 2. Bearish Engulfing Pattern: EURUSD 5-Minute Chart
If you look back at figure 1 you’ll notice that right before the bullish engulfing candle pattern, there was a bearish engulfing pattern as well. Engulfing candles occur quite often, which is why we need to some sort of other filter to trade them. I opt to use the trend.
Forex Engulfing Candle Trading Strategy
Engulfing candles occur often. While its appearance signifies a sharp short-term change in direction, many of these patterns aren’t of concern. In a trend there impulse waves and corrective waves. Ideally we want to enter on corrective waves, or pullbacks, and then “ride” the impulse for a profit.
The engulfing candle provides us a signal that a pullback is over, and the trend is about to resume. In the case of an uptrend, the bullish engulfing pattern signals that the selling which occurs on a pullback is over, and the buying is resuming. The trend doesn’t always resume right away, we may simply get a small push in the trending direction before the pullback resumes. Losing trades occur, and that is OK, as all losing trades can’t be avoided. Experienced traders can actively manage trades when this occurs, making a small profit or small loss. Alternatively, simply let the price hit your stop or target (discussed shortly) and let the odds of the trade, and having a larger potential profit than risk, work in your favor.
Figure 3. Bullish Engulfing Candle Trading Strategy in Uptrend
Get a current short, medium and long-term analysis of the EURUSD free…instantly: EURUSD Trend Analysis
For a bullish engulfing candle in an uptrend, the stop-loss is placed just below the low of the engulfing candle.
In the case of a downtrend, the bearish
engulfing pattern signals the buying which occurs on a pullback is over,
and the selling is resuming.
Figure 4. Bullish Engulfing Candle Trading Strategy in Downtrend
For a bearish engulfing candle in a downtrend , the stop-loss is placed just above the high of the engulfing candle.
Engulfing candles are simply an entry
technique, and therefore don’t provide a profit target. Profit targets
can be established using Fibonacci Extensions.
Apply the Fibonacci extension tool to the impulse wave and the pullback
to get an indication of where the price will go on the next impulse
wave.
Alternatively, use a 1.6:1 or 2:1 reward to
risk ratio. For example if you risk is 10 pips, your profit target is
16 or 20 pips respectively.
To help filter which trade signals you
take, and isolate the trend, you wish to employ other indicators, such
as trendlines or a moving average.
Forex Engulfing Candle Trading Strategy Entry Point
The traditional method is to let candles
complete before entering. That means once the the engulfing candle
finishes and a new one begins we enter the trade. Yet price bars are
arbitrary. There is no relevance to the close of a 1, 5 or 15-minute
candle. Therefore, we are watching for these signals in real-time, and
as soon as we see an engulfing pattern with the proper setup we trade
it, without letting the bar complete.
In the stock market the daily open and
close aren’t arbitrary, they are set and have impact. Therefore, stock
traders may opt to let daily bars complete. Intra-day bar timed bars are
still arbitrary.
Figure 5 shows how this works in a downtrend.
Figure 5. Forex Engulfing Candle Trading Strategy Entry Point
There are a number of reasons for doing
this. Mainly, a timed price bar is arbitrary (if there are questions on
this, I will respond to it in the comments section).
Also, it helps to reduce risk. Engulfing
candles show a powerful change in direction. If we wait for a bar to
complete it may have already run significantly, which means our stop is
bigger and our profit potential is diminished.
Finally, we’re trading with the trend, so
probability is already on our side. Getting in before a bar closes
doesn’t change our odds of success.
It is possible that when we look back at
our trades, an engulfing pattern may not be present. By entering early
we allow for possibility that by the time the bar closes it is no longer
a traditional pattern. Yet in real-time it exhibited the shift in
momentum we were looking for, and that is all that matters.
The engulfing signal doesn’t necessarily
have to come from one bar either. Assume we have a downtrend, and a
pullback moving higher. Then a down (red) bar comes, but it isn’t quite
an engulfing candle. A few seconds after another down (red) starts
taking out the lows of prior up (green) candles. To me this is a still a
valid entry. Even though it was over a number of candles, it still
shows the change direction. Once again, traders need to rid themselves
of the notion that there is something magic about the close of a bar,
especially in forex day trading. For examples on how to use multiple
bars to enter a trend during a pullback, see the ABC Forex Trading Strategy Video. The video also provides some other information which will helpful in reading trends.
Forex Engulfing Candle Trading Strategy – Final WordThe goal of the strategy is to isolate a trend, and then use engulfing patterns to signal the pullback is ending and the trend is resuming. Not every pullback ends with an engulfing pattern though, sometimes we can use multiple bars to signal the end of a pullback (see video mentioned above).There is no need to wait for the engulfing candle to complete. Once it has engulfed the prior candle, take the trade. Engulfing patterns don’t have a specific profit target, therefore using a Fibonacci extensions or a fixed reward to risk ratio. Stops are placed above the high of a bearish engulfing pattern, or below the low of a bullish engulfing pattern.
If trading on a 1 or 5 minute chart, trying using an ECN forex broker with a near zero spread. Here’s the ECN broker I use (they also have normal accounts).With an ECN broker you can more efficiently exploit intra-day opportunities, since you aren’t concerned about the spread.
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