In Today’s Article You’ll Learn:
- An Introduction Into What Engulfing Candle Are And What Role They Play In The Market
- How To Identify Engulfing Candles On Your Charts
- An Easy Method You Can Use To Trade Engulfing Candlesticks Effectively
What Are Engulfing Candlesticks ?
Another candlestick which is highly important in your knowledge and understanding of the market is the engulfing candle.
Engulfing candles are another weapon to add to your arsenal of price action trading strategies, like pin bars they are very powerful when found in the right location and can be traded without risking a lot of money. Before we talk about how to trade engulfing candles, I need to give you a bit of background as to what engulfing candles mean in the context of the market as well as a how you identify them on your charts.
What Do Engulfing Candles Mean ?
Okay firstly engulfing candlesticks begin and end every movement in the market.
So whenever you see the market go from being in an up-trend to a downtrend at the beginning of that movement an engulfing candlestick would have been present in some way shape or form.
This is due to what the engulfing candle itself represents.
You know it takes a lot of money for the market to change direction ?
Have you ever heard Newtons law of motion ?
Newton’s law of motion states that an object in motion will stay in motion in its current direction until acted on by an opposing force which is equal to or greater than the current force causing the object to move.
See any parallels between this law and trends in the market ?
Lets rewrite the law:
The trend will keep moving in its current direction until enough people decide to come in and buy/sell which causes the trend to either stop or reverse.
You know I remember reading somewhere that to move the price of the exchange rate of EUR/USD by 1 pip requires 50 million !
I know unbelievable right think of how small a distance that is in the market !
Engulfing candles are the result of big money coming into the market usually by large banks or other financial institution’s.
This is what makes engulfing candles such a formidable trading strategy.
If a large bank has come into the market and brought then its highly likely the market its going to go up, these institutions don’t mess around when it comes to making money, they want to make the maximum amount of cash, to do that they constantly need to change the direction of the market in order to make people lose money.
What Do Engulfing Candlesticks Look Like ?
Engulfing candlesticks, while not as obvious to identify as pin bars, are still pretty easy to find on your charts.
The one defining characteristic of engulfing candlesticks which makes them stick out from the other candles you’ll see on your charts, is they have a large body which is always bigger in size than the body of the candlestick seen immediately before it.
The image below illustrates this.
The name engulfing comes how the engulfing candle wraps itself around the previous candle like you can see in the image above.
The setup begins when we see a large bullish candle which happens to be immediately followed by a bearish candle, this second candle is a bearish engulfing.
Notice how the body of the bearish engulfing candle is bigger than the body of the bullish candle seen before it.
This is what you are looking for when trying to identify engulfing candles.
Here’s an example of a bullish engulfing candle.
The same characteristics are present in this image as in our bearish engulfing candle example.
The only difference here is, instead of the previous candle being bullish its bearish, the body of this bearish candle gets completely engulfed by the body of the bullish engulfing candle.
The engulfing candlestick itself must be the opposite of the candle before it.
In other words if your were trading a bearish engulfing candle, the candle in which it engulfs must be bullish, you cannot have a bearish engulfing candle engulf a bearish candle, if it does it’s not considered an engulfing candle.
This is true for the bullish engulfing as well, a bullish engulfing must engulf a bearish candle for it to constitute to being a trade setup.
How To Trade Engulfing Candlesticks
We trade engulfing candles in a pretty similar way to how we trade pin bars.
Although there are some key differences between the two methods there are also a lot of similarities.
Just like we would when trading pin bars we’ll use pre-marked levels of support and resistance as our places to which we are looking for engulfing candles to form, as well as always trading in the direction of the current trend to give us the best possible odds of having a successful trade.
We determine the direction of the trend by analyzing the swing highs and swing lows the market has created.
If you would like a full guide on how to determine the direction of the trend then check out my article on trends in which I take you through a simple step by step process which will allow you to know definitively what the current trend in the market is and, which way it is likely to go in the future.
Make Sure Its The Right Size
One thing that traders tend to do wrong when it comes to trading engulfing candlesticks, is trading ones which are the wrong size.
Although engulfing candlesticks come in various shapes and sizes,( some can be bigger than others for example), how big an engulfing candle is has a dramatic effect on whether your trade will end up being successful or not.
What I mean by this is we only want to trade engulfing candles that fit within our risk thresholds.
The engulfing candle in this image is far too big for us to be able to trade effectively.
Even though all the characteristics of a typical engulfing candle is present in this example, the size of the candle itself means the distance of our stop-loss from our entry point will be unfavorable for us in terms of how much we are risking in relation to how much we can potentially gain.
Engulfing candles like the one in the picture above tend not to work out as often as smaller engulfing candles.
What you’ll find if you do trade an engulfing like the one above is, shortly after placing your trade the market will move against you, the reason as to why this happens is based upon the psychology of the losing traders who participate in the markets.
Many people who trade currencies do so not based upon a particular method or strategy but on reactive tendencies.
Commonly what these reactive traders do is they will see the market move up or down strongly as evidenced by large bullish or bearish candlesticks and then enter traders in the direction of that movement, no analysis will be done they’ll just place the trade and hope that it works out.
The reason they do this is due to a common psychological pitfall that effects many traders called fear of missing out.
In the traders mind they feel like if they don’t place a trade on this movement then their going to miss out on a lot of potential profits, their decision-making process is based on reacting to quick changes in the market rather than anticipation and prediction methods like I teach on this site.
These traders have yet to learn the importance of patience in their trading so as usual they tend to lose money.
You don’t want to trade engulfing candles any bigger than the one in the image above.
Trading engulfing candles any bigger than the one seen above means you are running the risk of being in a short-lived market movement in which you wont be able to make much money or even worse lose money.
I understand knowing if an engulfing candle is the right size can be quite subjective, unfortunately I cannot give you a concrete answer as to what size an engulfing candle should be, in time, which engulfing candles you should trade will become more clear to as you will have had much more experience in identifying and trading them.
As long as the engulfing candle has a body bigger than the previous candle’s body it’s considered an engulfing, even if its only marginally bigger, if the body is any smaller than the candle before it it’s not an engulfing setup.
Entering The Trade
Your entry on an engulfing candle setup is made when the candle closes, I talk about the importance of this in the pin bar article.
What this means is if you see an engulfing candlestick on the 1 hour chart which you have decided to trade (and lets say its 15 minutes until the end of the hour) you must wait until the end of the hour before placing the trade, if you place it before, you run the risk of the engulfing candle developing into something else entirely.
For example, the shape of the engulfing candle could change into a candle where the body itself does not engulf the body of the previous candle thus making it not an engulfing candle anymore, so in this situation your now stuck in a trade based on something completely different to your original idea which, if not acted on quickly, will end up with you losing money.
The entry itself will be made using a market order, pending orders do not tend to work well when trading engulfing candles.
What About The Stop Loss ?
The location of your stop-loss when trading engulfing candles is exactly the same as the position I showed you for trading pin bars.
If your placing a trade on a bullish engulfing candle then your stop must be placed 10 pips below the engulfing candle low.
For this bearish engulfing we would put the stop 10 pips above the high of the engulfing candle (it’s a bit difficult to see the high in the image above)
When Do I Move The Stop ?
When it comes to moving the stop-loss on engulfing candle setups the rules we use are the same as the ones we follow for moving the stop on pin bar setups.
When the market makes a higher swing high (if your trading a bullish engulfing) then you move your stop-loss to the entry point of the trade (if you don’t know how to do this check my article on stop losses).
If you have placed a trade based on a bearish engulfing candle, when the market makes a lower swing low you move the stop to your entry point of your trade.
The main thing you have probably gathered from this article is how similar trading engulfing candles is to trading pin bars. I mentioned in the pin bar guide that the next step you should take after mastering pins is to start learning how to trade engulfing candles.
The many similarities between them is why I suggested this, making the transitions from trading pin bars to trading engulfing candles is very simple because half of the information is already known by you.
If there’s one downside to trading engulfing candles it would be not being able to trade them on the daily chart.
This means if you work during the day its going to be difficult to add engulfing candlesticks to your trading strategy, this is because the distance of the stop-loss from the entry point is much larger when trading engulfing candles on the daily time frame compared with trading them on the 1 hour chart, the risk reward ratio is not favorable and if you do happen lose money on a trade it will be tough for you to make it back.
Fear not though because currently I’m working on figuring out a method of reducing the risk on the engulfing candles setup so your able to trade it on the daily chart, it may take a while to do this but I’ll keep you updated, hope you enjoyed the guide thanks for reading.