How to “Engulf” Pips with Engulfing Patterns
I have always asked many traders this question: why chase a market trend that is already far gone and in danger of reversing, when you can simply exercise some patience and catch the reversal using a strategy that has worked wonders so many times in the past? Almost all the time, I am met with total silence. The temptation to go chasing trends is something a lot of traders may possibly stop yielding to if they start using engulfing candlestick patterns.
What are engulfing candlestick patterns? An engulfing pattern is a reversal candlestick pattern made up of two candlesticks: a shorter candlestick (Day1 candle) which is the colour of the existing trend, and a longer candlestick (Day 2) candle which is the colour of the new trend. From this definition, we can see that there are two types of engulfing patterns:
a) Bearish engulfing pattern, made up of a short bullish candle followed by a longer bearish candle whose high is higher than the Day 1 high and whose lower is lower than the Day 1 low.
The bearish engulfing pattern is a reversal pattern and so is of importance solely at the top of an uptrend.
b) Bullish engulfing pattern, made up of a short bearish candle followed by a longer bullish candle whose high is higher than the Day 1 high and whose lower is lower than the Day 1 low.
The bullish engulfing pattern is a reversal pattern which is of importance to the trader if it occurs at the bottom of a downtrend.
How to Trade With the Engulfing Patterns
The engulfing patterns are only moderately reliable for trading signal generation. Therefore, other methods of analysis must be used along with these patterns for confirmation of the change in trend that will give the trader the go-ahead to buy or sell. These methods are:
a) Observing the candle that follows the longer Day 2 candle to see if it moves in the direction of the new trend.
b) Combining the engulfing pattern signal with a momentum indicator that will indicate an oversold or overbought market situation which will give a sure signal that a trend is truly over.
Of the two methods, option B is preferable because it helps the trader make an early entry into the market. Waiting for confirmation by a subsequent candle will cause the trader to lose out on a lot of pips, especially if the signal is being taken from a daily chart.
The Engulfing Strategy
This is a very simple strategy.
1) Bullish engulfing + Stochastics oscillator = Buy. If signal occurs at a support, signal is strengthened.
2) Bearish engulfing + Stochastics oscillator = Sell. If signal occurs at a resistance, signal is strengthened.
When these setups appear on your chart, open the corresponding trade at the open of the next candle. This is all you need to start “engulfing” pips consistently from the forex market. So next time the temptation comes to get into the market when a trend has been on for some time, resist that temptation and wait for the reversal setups to appear. The patient dogs always get the fattest bones.