How to Trade Bullish and Bearish Engulfing Candlestick Patterns?

Bullish and bearish engulfing candlestick patterns are powerful reversal formations that generate a signal of a potential reversal. They are popular candlestick patterns because they are easy to spot and trade.
 

Structures

A bullish engulfing candlestick pattern occurs at the end of a downtrend. It consists of two candles, with the first candle having a relatively small body and short shadows, also known as wicks. The second candle, on the other hand, has longer wicks and a real body that engulfs the body of the previous candle.

As seen in the illustration above, the second candle completely overwhelms the prior candle. For a pattern to qualify as bullish engulfing, the high of the second candle should hit higher prices than the high of the prior candle. The same scenario applies for the low. 

 

Ideally, the closing price (top of the body) should also be higher than the highest point of the wick of the prior candle. This scenario gives further significance to the second candle and shows that the bulls have control over the price action now. 

 

The bearish candlestick pattern follows the same line of thought, the only difference is that it is a bearish reversal pattern that occurs at the top of an uptrend. The first candle is a bullish candle that signals the continuation of the uptrend, before the appearance of the powerful bearish candle that completely shuts down the prior candle.

 

Moreover, if the second candle is huge and long, it can practically close the door for you to open a trade, as your stop would be placed far away from the entry price i.e. high risk and not such high reward.

 

The best way to learn the strengths and weaknesses of the bullish and bearish engulfing patterns, as well as other candlestick formations, is to use the MetaTrader 5 trading platform and pay close attention to when these formations are created and how the price action behaves.

Importance and limitation of engulfing patterns

The significance of engulfing candles in trading is high. As traders, we aim to capitalize on new trends when markets change direction. Reversal patterns, such as bullish and bearish engulfing patterns, signal an impending change in the price direction, as the so far dominant force has started losing momentum, which allows the other force to capitalize. 

 

Both patterns take place at the end of a strong trend. The idea behind the bullish engulfing pattern signals that the second candle is powerful enough to initiate a new trend. Since the low of the second candle is lower than the one of the first candle, it signals that the bulls were able to push the price action from the session lows to higher prices, which is not seen during the first prior session. 

 

However, as other candlestick patterns, engulfing formations have their own limitations. While they are quite powerful when they occur at the end of a strong trend, they are almost non-tradeable when they appear in choppy trading. 

How to trade the bullish engulfing pattern
In the chart below, we see a AUD/USD daily chart. The price action had been putting in a series of lower highs and lower lows to ultimately create three swing lows. Following a new short-term low, the price action suddenly presses higher to create a strong, powerful bullish candle.


 

All elements are in place, and the bullish engulfing formation is formed. Investors recognize this pattern and use this opportunity to capitalize on the imminent change in the trend direction. The price action then pushes higher to record two swing highs, and ends up in ultimately trading at higher levels. 

 

In this particular example, we see the power of a bullish engulfing pattern. The trend reversed after the second candle generated a signal that the bulls have taken control over the price action, and the downtrend may be finished.

 

How to trade the bearish engulfing pattern

The second example that we show here is a great opportunity to see the engulfing pattern at its best. The USD/CAD price is trading lower on a daily chart. At one point, the price rebounds strongly before it reverses again to continue trading lower, and ultimately printing the new short-term low.