Introduction
Choosing the best trading platform is not sufficient to succeed in trading. One has to acquire a thorough understanding of how to conduct technical analysis and recognize patterns in charts. The bullish and bearish engulfing patterns are common patterns that traders often come across.
These patterns offer insights about upcoming reversals that are expected in the market trends. They become even more beneficial for traders who are making use of the margin trading facility. In this post, we will discuss how to understand and interpret these patterns.
Understanding Engulfing Patterns
What is a Bullish Engulfing Pattern?
When a downtrend in a chart is about to end, and there is a potential upward move coming up, a two-candle reversal pattern will appear.
A smaller red candle (bearish) would be engulfed by the bigger green candle (bullish). This engulfing pattern is called a bullish engulfing pattern and it signals the market that the bulls are taking over the stock, and are shifting the momentum from selling to buying.
What is a Bearish Engulfing Pattern?
Similarly, when an upward trend in a chart is about to end, and there is a potential downward move coming up, a two-candle reversal pattern will appear. A smaller red candle (bearish) would engulf the bigger green candle (bullish).
This engulfing pattern is called a bearish engulfing pattern and it signals the market that the bears are taking over the stock, and are shifting the momentum from buying to selling.
Identifying Engulfing Patterns
Analyzing the Market Context
While taking insights from the engulfing patterns one has to look for other signs that back up the indications thrown by the engulfing patterns. When the price trend is about to shift from selling to buying these trends happen at a support level usually.
And conversely, a resistance level indicates that the price trend is about to shift downward. When the engulfing patterns are backed by these support/resistance levels, one can take the signal with a higher level of confidence.
Confirmation with Volume
Besides the cross checking with support/resistance levels, one can also look at volume for confirming what the patterns suggest. Higher volume with the bearish candle while a bearish engulfing pattern forms, strengthens the pattern’s signal. Similarly, higher volume with the bullish candle while a bullish engulfing pattern forms, strengthens the bullish signal.
Trading Strategies with Engulfing Patterns
Bullish Engulfing Trading Strategy
1. Identify the Pattern:
This pattern can be located toward the end of downtrends. Support levels also indicate a potential bullish engulfing pattern.
2. Confirm with Volume
The volume of the bullish candle would be higher than the volume of the bearish candle.
3. Entry Point
When the next candle opens, upon confirmation of the pattern, enter a long buy position.
4. Stop Loss
The stop-loss order needs to be placed at a level lower than the bottom of the pattern for better risk management.
5. Take Profit
A take-profit order also needs to be set, at an estimated level of resistance. Or a trailing stop could be used to lock in profits while the price moves upward.
Bearish Engulfing Trading Strategy
1. Identify the Pattern
This pattern can be located toward the end of uptrends. Resistance levels also indicate a potential bearish engulfing pattern.
2. Confirm with Volume
The volume of the bearish candle would be higher than the volume of the bullish candle.
3. Entry Point
When the next candle opens, upon confirmation of the pattern, enter a short sell position.
4. Stop Loss
The stop-loss order needs to be placed at a level higher than the top of the pattern for better risk management.
5. Take Profit
A take-profit order also needs to be set, at an estimated level of support. Or a trailing stop could be used to lock in profits while the price moves downward.
Risk Management and Best Practices
Besides the above-mentioned steps like using stop-loss, take-profit orders and the trailing stop option, risk can also be managed better in the following ways.
To strengthen the signals from the engulfing patterns, one should use them in combination with indicators such as moving average, relative strength index and so on. They can offer an added layer of reliability to the insights that the engulfing patterns offer.
Conclusion
Crossing patterns such as Bullish and Bearish Engulfing are particularly helpful when trading accounts since they help in detecting potential market reversal points.
Engulfing patterns can also be effectively used in combination with other technical analyses, while it is equally important to establish proper risk management systems in order to enhance trading performance even more.
