The Engulfing Pattern
In a single candlestick pattern, the trader needed just one candlestick to identify a trading opportunity. However, when analyzing multiple candlestick patterns, the trader needs 2 or sometimes 3 candlesticks to identify a trading opportunity. This means the trading opportunity evolves over a minimum of 2 trading sessions.
The engulfing pattern is the first multiple candlestick pattern to consider. It needs 2 trading sessions to evolve. Typically, a small candle forms on day 1 and a relatively long candle on day 2, which appears to engulf the first. If this appears at the bottom of a trend, it’s called a Bullish Engulfing pattern. If it appears at the top, it’s called a Bearish Engulfing pattern.
The Bullish Engulfing Pattern
A two-candlestick pattern appearing at the bottom of a downtrend. As the name suggests, this is a bullish pattern prompting traders to go long.
Prerequisites:
- The prior trend should be a downtrend
- P1 should be a red candle confirming bearishness
- P2 should be a blue candle that fully engulfs P1
Thought Process:
- Market is in a downtrend; P1 confirms this with a red candle
- P2 opens near P1’s close, dips, then closes higher than P1’s open due to buying interest
- This results in a long blue candle, rattling the bears
- Expected continuation of bullish momentum
Trade Setup:
- Buy near P2’s close
- Risk-taker buys on P2 after confirming engulfing
- Risk-averse waits till the day after P2 and confirms a blue candle
- Stop loss: Lowest low between P1 and P2
Example (DLF): P1 OHLC = 163/168/158.5/160, P2 = 159.5/170.2/159/169. Conditions validated, trade is successful.
The Bearish Engulfing Pattern
A two-candlestick pattern at the top of a trend. It's the inverse of a bullish engulfing pattern, and suggests a short trade.
On P1, bulls are in control; P2 opens higher but then selling pressure causes it to close below P1’s open, forming a red candle.
Trade Setup:
- Risk-taker: Short at close of P2 after validating the pattern
- Risk-averse: Short the day after P2 only if it's a red candle
- Stop loss: Highest high between P1 and P2
Example (Ambuja Cements): P1 OHLC = 214/220/213.3/218.75, P2 = 220/221/207.3/209.4. Trade was successful.
The Presence of a Doji
A doji after an engulfing pattern increases the strength of the signal. Doji represents indecision and when followed by a strong engulfing pattern, it usually leads to a significant move.
- Uptrend confirmed
- Bearish engulfing on P2
- Doji on P3 signals uncertainty
- Expected strong move down on P4
The Piercing Pattern
Similar to a bullish engulfing but P2’s blue candle engulfs only 50%–99% of P1’s red candle.
- Risk-taker buys on P2 close
- Risk-averse buys day after P2 if it’s a blue candle
- Stop loss: Low of the pattern
The Dark Cloud Cover
A bearish version of the piercing pattern. P2’s red candle engulfs 50%–99% of P1’s blue candle. Trade it like a bearish engulfing pattern.
A Perspective on Selecting a Trade
Stocks in the same sector may show different candlestick patterns. Choose the one with a more reliable pattern and that satisfies more checklist criteria.
Key Takeaways
- Engulfing patterns evolve over 2 sessions
- Bullish engulfing: P2 blue candle engulfs P1 red candle, appears in downtrend
- Bearish engulfing: P2 red candle engulfs P1 blue candle, appears in uptrend
- Piercing and Dark Cloud Cover are partial engulfing patterns
- Doji after a pattern can amplify signal strength
- Select trades based on pattern quality and checklist conformance