What two candlesticks can tell you about the price movements?
Before this, we have spoken about stock chart patterns based on one single candlestick such as the Marubozu, The Spinning Top, The Doji, The Hammer, and The Hanging Man. Now, it’s time for us to advance further and look at two candlesticks! Heck yeah.
Before we proceed, if you have absolutely no idea how the price charts work in trading (stocks, forex, etc.), check out our article below!
An engulfing candlestick pattern can be either bullish or bearish, depending on the direction of the price movement. A bullish engulfing candlestick pattern occurs when a small red (bearish) candle is followed by a large green (bullish) candle that completely engulfs the small red candle.
The pattern will often occur within two consecutive periods (usually days) in the market. To make identifying easier, we’ll first name the small one as D1 (referring to day 1’s candle) and D2 (referring to day 2’s candle).
Here’s how you can identify a bullish engulfing candlestick:
Does the D2 candle have to engulf only the body of the D1, or does it have to engulf everything including the tails? The safe answer to it is that it actually depends on your personal experience, depending on the type of stocks or the market you’re trading in.
The less safe answer is that there are two schools of thoughts when deciding if it’s considered an engulfing candlestick or not, one says that D2 needs to engulf every single bit of the D1, while another is of the opinion that as long as the body of the D1 is engulfed by D2 that’s fine.
The pattern appears in a downtrend, where the selling sentiment is much higher compared to its buy sentiment, and it continues going so, up until it reaches the lowest low (during D1), but then, in the next day (D2), the price opens as expected, which is low. The sentiment however changed as price increased dramatically, up to a point that it’s higher than D1’s open or high.
This pattern suggests a potential reversal of a downtrend, with buyers taking control of the market and pushing the price higher — or in simpler terms, the moods have changed, and there might be a chance that the downtrend might reverse into an upward trend.
There are generally two ways in which you can approach a trade, by playing it risky or by being risk averse.
If you’re a risk-taker, what you can do is buy at D2’s closing price (when the market nears closing time). However, be sure to observe these two conditions — first, the price nearing the close of D2 is higher than D1’s open; and second, D2 opens lower or the same as D1’s closing price.
You can put your stop loss at whichever point is the lowest point that the price moved to within the two days (not open or close price). Say, if the bottom tail in D1 is the lowest point at $100, then you put your stop loss at $100.
If you’re a risk-averse trader, then you might want to wait until it’s near the closing time of the next day to see if the price on the third day is in fact bullish. If it is, then you might want to buy it before the market closes.
Just like when going risky, you can put your stop loss at whichever point is the lowest point that the price moved to within the two days (not open or close price). Say, if the bottom tail in D1 is the lowest point at $100, then you put your stop loss at $100.
However, given that you’re buying on the third day, you might want to brace to buy at a price way higher compared to if you bought on the second day (D2).
Traders often use the Engulfing Candlestick pattern in conjunction with other technical analysis tools to confirm potential trading opportunities and make informed trading decisions. It is important to keep in mind that no single technical indicator or pattern is a guaranteed predictor of future price movements, and traders should always use risk management strategies to protect their capital.
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