Secret Trading Tip #19

Candlesticks & Engulfing

Candlestick charts have all kinds of potential patterns that technicians are watchful for. One of the easiest to spot is an engulfing pattern. This set-up consists of two candlesticks, one of which is “engulfing” the previous one. That means the body of the second candlestick is longer than the first one. It doesn’t have to extend beyond the wicks of that first candlestick, just the real body.
  
Spot an engulfing candlestick and you might be seeing a reversal signal

When the real body of a second candlestick extends beyond the previous one, the participants are behaving in a particular way. The candlestick is bigger because some combination of opening price and buying or selling pressure is making it bigger. These combinations can tell you if there is potential for an existing trend to change.
Candlestick fans are watching for an engulfing candlestick of a different color
The reversals are spotted when there is a hollow candlestick engulfing a filled one or vice versa (red and green if you are using a chart program with colors.) Don’t get caught up in anything involving a doji – those are pretty easy to engulf.

If the market was in an apparent uptrend and a hollow (or green) candlestick is engulfed by a filled (or red) one, this might be a signal of a bearish reversal. The second candlestick shows that the market opened above the prior closing price and then selling pressure came in and the market was pushed below the prior opening price.

Finding a hollow (or green) candlestick engulfing a filled (or red) one could be a bullish reversal signal in an established downtrend. In this case, the hollow candlestick would show that the session opened at a price below the prior close, where the real body starts below the filled candlestick from the previous session. Buying ensued and the market price moved through and above the prior opening price.

Engulfing patterns can be easy to spot – look for larger candlestick bodies to indicate firmer potential signals

Remember, watch for the real body of a second candlestick to engulf the first. If it is a contrary to the prevailing trend, you might have a reversal signal on your hands. Look at the buying or selling pressure as an indication of market direction. As with all technical chart patterns, keep an eye on the following trading sessions to confirm the move. Watch for further weakness after a bearish engulfing pattern or continuing strength on a bullish engulfing pattern.

Larry Levin
President & Founder- Trading Advantage
TradingAdvantage.com