Secret Trading Tip #19 Candlesticks & Engulfing

Last time Larry Levin was a guest on the Traders Blog, we received a ton of great feedback. So, we decided to ask Larry if he'd be interested in sharing another one of his trading tips. Of course, he was happy to send over another. Today' tip is on engulfing patterns, a commonly found candle-stick setup. Be sure to comment with your thoughts and visit Larry for more trading pointers.

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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.

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Larry Levin
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8 thoughts on “Secret Trading Tip #19 Candlesticks & Engulfing

  1. Does today's action on GE count as bearing engulfment, even if prices fell on both days?

    Date Open Close
    Apr 21 20.78 19.95 (On heavy volume, but shouldn't matter for engulfing pattern I guess)
    Apr 20 20.52 20.40

    I hope Adam Hewison can jump in and make clarifications.

  2. @Gary:

    On March 29, the range between open and close price was ($82.26 - $80.37) = $1.89
    On March 30, the range between open and close price was ($82.76 - $79.90) = $2.86

    On the day of engulfment, the up/down movement was opposite of the previous day. I.e. on March 29, NOV stock was up and on March 30, it was down.

    Combination of the above 2 factors is what I understand as bearish engulfment, which told me to pull the trigger:
    i.e. Range is engulfed and direction is changed.

    To further illustrate the point, if the stock was down on March 29 and up and March 30 with the same ranges, I would call it bullish engulfment and would have bought some call options.

    Does this make it clear, Gary?

    Ram
    Ra****@ho*****.com

  3. Are we talking about something that always happens on open? Shouldn't this be A BIT less complex? The tip would help more if it spoke to a broader every level of understanding. Or possibly there are a few volumes of info that are assumed and understood by many of your readers that I don't have. If so, where is Mrs Shelby's 1st grade candle stick and tea reading class? (Maybe someone could suggest a learning format for this very important type of charting.)
    Thanks

  4. I find Ram's post difficult without the visual representation.

    I cannot see how Mar 30, 2011 82.76 79.90 can be a 'bearish engulfing pattern'when its smaller in length to the preceding day(?)

    It seems to be an 'engulfing in reverse'. What have I missed here Ram?

  5. yes dont go on this alone butstochastic being over or under or RSI above or below the 50 line is a good combo

  6. I'd love to know the actual percentage of accuracy from backtests. Like any other technical analysis indicator, I'd be surprised if it correctly forecasts a reversal more than 40% of the time.

  7. I was able to make my first profit after understanding the engulfment pattern. This is what I noticed on price of NOV on March 29 and 30:

    Date - Open Price - Close Price
    Mar 30, 2011 82.76 79.90
    Mar 29, 2011 80.37 82.26

    So, I bought some put options for the front month at a strike of $80 for $4.80. The underlying stock went down to around $74 in 10 days. I was able to sell the options for $7.60, making a nice 50% profit after commissions.

    However, I noticed a similar bearish engulfing pattern on SLV that didn't end up in a bearish move:
    (luckily I didn't act on it!)

    Date - Open Price - Close Price
    Apr 11, 2011 40.24 39.21
    Apr 8, 2011 39.30 39.86

    So, I guess you also need to care about the macroeconomic factors, the industry trend of the specific stock, etc.

    Also, volume was heavy on the day of engulfment for both of the above instances, but I guess that doesn't matter. But I am not sure and have the same question as Ed. Someone more knowledgeable can confirm.

  8. Should I place a trade order for the next opening day when I see an engulfing candle? Does volume matter?

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