A brief history of the Candlestick
Candlesticks were developed by Japanese rice traders nearly 300 years ago.
There are a number of different candlestick patterns which are worth keeping an eye out for, but since we haven’t got 300 years, we’re going to have a look at just one of the top candlesticks patterns for now, which should set you off on the right track.
Introducing the Engulfing Pattern
So say hello to the Engulfing Pattern, which is when the second candlestick ‘engulfs’ the previous candlestick in the opposite direction.
This shows a pure rejection of the previous price action and is a definite sign that the market did not take kindly to the previous move. The engulfing pattern can therefore be both a Bearish reversal signal (if spotted at the top of an uptrend) or a Bullish one (if at the bottom of a downtrend).
A Bullish Engulfing candlestick pattern is when an initial downward candlestick (close lower than open) is immediately followed by an upward (close higher than open) candlestick that is bigger than it, or entirely engulfs it, that is to say the low is equal to or lower than the previous low, the high is higher than the previous high, and the close is higher than the previous open.
Take a look at these charts to help you better understand what we’re talking about.
This essentially means that from a supply and demand point of view, the buyers have stepped into the market to ensure it doesn’t drop any lower. This could then result in a push higher as the buyers overwhelm the sellers. Therefore, it can be taken as a Bullish signal.
The Bearish Signal is simply the opposite of this, as seen below.
Engulfing in a strategy
A really nice trading strategy is to look for Bullish engulfing signals in uptrends and Bearish engulfing patterns in downtrends, as they can be good signs of trend continuation.
Like Pin Bars, the real trick to this is to look for obvious signals, the ones that really stand out. For instance, if you have an overall downtrend but have recently retraced higher, you will then get a nice Bearish engulfing which could be a great entry to join the trend lower.
As in the Pin Bar strategy, what we want to look for is the ability to place the stop above the Bearish engulfing high or below the Bullish engulfing low, and then look for at least 2:1 risk reward for the trend continuation.