|In candlestick charting, the engulfing pattern is a major reversal signal with two opposite color real bodies. The second body must begin and end above and below the first body, respectively, giving it the illusion of "engulfing" the first candlestick. The two bodies must be of different colors. The shadows, or "wicks," are irrelevant in this pattern. As a second condition, in order to get a reversal signal, the prices must be in an up- or downtrend. As with other candlestick patterns, the engulfing pattern is more reliable when associated with additional confirmation signals. |
During a bottoming reversal (when prices are in a downtrend), the first candlestick body will be black, and the second will be white. This shows the switch of traders' attitude toward the market as the bullish forces take control of the bears, ending the second session on a strong, positive close. The opposite is true for bearish engulfing patterns.
|Here are some rules to reinforce the engulfing potential as a reversal pattern: |
-The first day of the engulfing pattern has a small real body and the second day has a big one. This would indicate a decrease of the prior trend's force and an increase in force of the newborn move. The signal is strong if the second candlestick body is 30% larger than the first.
|Let's see the daily chart of Dupont (Figure 1). The stock on June 7 (point A) printed a down gap accelerating to the downside. The next day, a hammer indicated that, very likely, the bears were not able to push prices lower, at least in the short term. During the following three sessions the stock moved lower, but prices did not manage to reach the hammer's low. On June 14 (point C), Dupont printed an engulfing pattern. The open was below the previous day's body and closed above it. This was a sign of strength that was confirmed the following day. Prices have quickly reached the $41 resistance. The bullish engulfing pattern was reinforced by the stochastic in the oversold area, although it was printed on low volume. The pattern is printed in a general condition of weakness, and therefore, it is not going to be a major reversal. However, it could be valid in the short term, applying proper risk management rules. Next, resistances are, respectively, $42 and $43.30. The low of the engulfing bar at $39.70 is now an important support.|
|FIGURE 1: DUPONT, DAILY. The stock has printed a bullish engulfing pattern that has initiated a short-term reaction after the one-month downtrend that brought prices more than 10% lower.|
|Graphic provided by: TradeStation.|
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