Strategy › Bullish Engulfing Pattern

Bullish Engulfing Pattern

Bullish engulfing is a Japanese candlestick pattern signalling the end of a downtrend and the beginning of a new uptrend or bullish retracement. This is a two-candle reversal pattern, which occurs on price charts after a trend peaked or bottomed out and a counter-trend action is expected. The trading signal is preliminary thus traders should wait for additional confirmation before entering the market.

Initially, engulfing patterns were noticed on the price charts of stocks and commodities as these asset classes often have different close and open prices of the next period. However, the reversal formations have been adopted for currency pairs and cryptos which usually have larger liquidity and equal close and open prices represented on separate candlesticks.

Nevertheless, engulfing patterns are useful in terms of showing traders attractive entry levels and indicating possible reversals of the price action.

What is a Bullish Engulfing?


Bullish Engulfing candlestick patterns consists of two candles. The first one typically represents a previous trend. The second candle has a larger body, which can absorb the previous candles body. In other words, the second candle engulfs the first one. The best case scenario for a trends reversal pattern suggests that open and close prices of the second candlestick represent a wider range than the first candle. However, some applications use equal close rate of the first candle and the open price of the second one. Shadows of both bars are not significant in this case as the main information is coming from candles bodies. However, long shadows might be useful in terms of determining further trends direction and calculating possible resistance and support levels.

How does the Bullish Engulfing pattern look like?


Below is an example of an Bullish engulfing candlestick pattern on the daily chart of the U.S. dollar index. The screenshot shows that after a sustainable downtrend, a candle gapped on the lower side, meaning that the open rate was lower than the previous candles close. As a result of price action, the bulls were able to chart a larger candle with the close price higher than the previous bar’s open. So the trading range was wider, and the second candle engulfed the first one.

After the pattern occurred on the price chart, the trends direction changed:

Bullish Engulfing Pattern

What does Bullish Engulfing candle mean?


The price action reflects a strong resistance or support level. At some point, the previous trend is getting exhausted and binary options traders cannot push prices in the same direction any more. In this case, the bulls or the bears (depending on the previous trend) start taking the market back under control. This causes a counter-trend action and the previous day’s achievement is getting erased by the next candle’s close. So the trend is losing momentum, the sequence of lower lows or higher highs is breached, and the likelihood of a reversal or at least corrections rises.

If you like this strategy, you might also be interested in this Hammer Candlestick

Sometimes volatile market conditions can come together with several changes in the momentum and trend’s direction. What really does differ directionless trade from a change in the technical sentiment is the trading volume. If the engulfing pattern appears on price charts together with a jump in the trading volume, then the sustainability of such a signal grows. Besides, conservative traders could wait for additional confirmation from a candle which comes after the engulfing pattern. If it closes the period with the same colour as the second candle in the engulfing pattern, then the trend’s reversal is confirmed.

Otherwise, the signal has to be ignored:

Bullish Engulfing Pattern

Bullish Engulfing pattern?


The bullish engulfing pattern appears on a price chart only after a sustainable downtrend when at least a few previous candles were in the red. The formation signals a possible reversal of the downtrend with an upcoming bullish retracement or a complete change in the trend’s direction. The first candle in the formation must be red (bearish), and the second candlestick must be green (bullish). The open price of the second candle can be equal or lower than the close rate of the first bar. The close rate of the second candle has to overcome the open price of the previous candlestick. After the engulfing signal was confirmed on a price chart, traders could consider buying CALL options.

Here is an example of a bullish Engulfing appeared at the bottom of the downtrend:

Bullish Engulfing Pattern

Bearish Engulfing pattern?


The bearish Engulfing pattern underlines the end of the previous uptrend, while an upcoming bearish rebound or a new downtrend might begin. The first candlestick of the bearish pattern is green, but the second one must be red. The open rate of the second candle in the formation should be lower or equal to the previous bar’s close, while the close price of the second candlestick has to be higher than the previous bar’s open. This sequence points to a shift in traders’ sentiment and a potential reversal of the price action. Therefore, after a bearish engulfing, traders should get ready to start buying PUT options for the underlying asset.

The screenshot below shows an example of the bearish Engulfing pattern at the peak of an uptrend:

Bullish Engulfing Pattern

The difference between bullish and bearish Engulfing candle pattern


The difference between the two kinds of engulfing candle patterns is in the mirrored reflection and context. It’s hard to imagine a bullish engulfing candle after an uptrend as it does not reverse anything. Such an example could indicate the strength of the bulls, which was obvious even without the pattern as the sequence of higher highs was still in play. The same story relates to a bearish engulfing candle during a downtrend, it does not make any sense. Bullish reversal formations suggest buying CALL options, and bearish patterns indicate a start of trading cycles to buy PUT options.

How does a Bullish Engulfing Pattern Work?


As far as this is a reversal pattern, binary options traders should find moments when the technical sentiment is changed. The trading strategy based on reversals suggests counter-trend price action thus traders should consider buying CALL options after the downtrend and PUT options after an uptrend. Below are the rules and conditions to enter the market according to the trading strategy based on engulfing patterns.

It is always important to take into account the context. The analysis has to have a multi-layer structure, fundamentals have to be considered as well. It’s understood that strong trends do not reverse without a reason, especially when it comes to long-term trends on weekly and daily charts. So several factors have to be triggered for a trend to reverse the direction. For instance, if an asset rose to an extremely expensive level where buyers are entirely absent, then the bears could retaliate and push the rate lower.

Conditions to buy CALL options on a bullish Engulfing pattern

  • If a downtrend was noticed with at least a few candlesticks in the red and a bullish engulfing pattern appeared on the price chart, traders should wait for additional confirmation before entering the market;
  • If a candle following the bullish engulfing pattern closed in the green, then traders should start buying CALL options for the underlying asset. Otherwise, traders should ignore the signal;
  • Another condition to confirm the reversal is that the engulfing candle has to come together with a spike in the trading volume (indicator below the price chart);
  • There is also an option to switch to a lower timeframe and buy CALL options with shorter expiration time after the bullish engulfing was confirmed on the basic timeframe of analysis.

Conditions to buy PUT options on a bearish Engulfing pattern

  • If a downtrend was noticed with at least a few candlesticks in the green and a bearish engulfing pattern appeared on the price chart, traders should wait for additional confirmation before entering the market;
  • If a candle following the bearish engulfing pattern closed in the red, then traders should start buying PUT options for the underlying asset. Otherwise, traders should ignore the signal;
  • Another condition to confirm the reversal is that the engulfing candle has to come together with a spike in the trading volume (indicator below the price chart);
  • There is also an option to switch to a lower timeframe and buy PUT options with shorter expiration time after the bearish engulfing was confirmed on the basic timeframe of analysis.

Engulfing patterns with technical indicators

Several additional technical indicators can be applied to double-check the trading signal coming after the engulfing. Binary options traders could consider using fast and sensitive oscillators which show overbought (for bearish engulfing) and oversold (for bullish engulfing) conditions before starting the trading cycle. If oscillators come out of overbought or oversold territory, then the trading signal is confirmed. Otherwise, the previous trend could continue moving rates in the same direction.

Another example of using engulfing patterns in combination with other technical tools is related to such tools as trend or momentum indicators. For example, if the MACD trend indicator confirmed the reversal with a crossover of its lines, then the likelihood of a reversal is higher. Another powerful tool is the Average Directional Index, which could have a shift in the technical sentiment confirming the reversal.

Examples of profitable trades


Here are several examples of how binary options traders can benefit in reversal trading strategy based on bearish and bullish engulfing candlestick patterns.

Buying PUT options for German stock index DAX 30 after a bearish Engulfing pattern

The daily chart below shows the German stock index DAX 30 in an uptrend. After the bulls were exhausted and the benchmark peaked at the beginning of November 2019, a bearish engulfing pattern appeared on the price chart as the sellers were active. After the pattern was confirmed by the following candle, a trader started buying PUT options.

The trading cycle brought four profitable deals with 24-hours expiration in a row:

Bullish Engulfing Pattern

Engulfing chart with trading volume

The daily chart below shows two engulfing candle signals for the USD/CHF currency pair. The first engulfing was bullish and it came along with a jump in the trading volume, which delivered the necessary confirmation before the trading cycle of buying CALLl options. As the price action shows, the uptrend lasted quite a long time and it was sustainable, offering a lucrative opportunity for binary options traders. However, the second example of bearish engulfing was not confirmed by the trading volume, and the bearish rebound was limited and short-lived, so traders could not take advantage of the trading cycle of buying PUT options.

Bullish Engulfing Pattern

Bullish Engulfing patterns with Stochastic RSI

This example shows how a fast and sensitive oscillator could work together with engulfing patterns. The first case points to a weak bearish momentum and the reversal did not last long. The opposite signal came from Stochastic RSI shortly after the bearish engulfing, and PUT options were not profitable. The second case is much more lucrative as Stochastic RSI performed a bullish crossover, coming off the oversold zone at the same time with the bullish engulfing candlestick on the price chart.

Bullish Engulfing Pattern

Conclusion


Bullish engulfing is a strong signal to start buying CALL options on a previous downtrend reversal. Engulfing happens not so often, however, the appropriate context and an additional confirmation make the formation a powerful tool for technical analysts and binary options traders. The bearish or bullish engulfing candle has to be larger than the first bar of the two-candle formation to absorb the previous price action and start a new trend.


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