The engulfing candle pattern is another important group, of which there are two main types, the bearish engulfing and the bullish engulfing. The concept of the candle pattern is simply that one candle has ‘engulfed’ the other wrapping around the previous days price action. The candle pattern on the left is bullish engulfing with the green candle wrapping around the red down bar, whilst the pattern on the right is bearish engulfing, with the red down bar engulfing the up candle of the previous day. In both case the candle that has been engulfed is fully enclosed within the body of the following day’s price action. Like the doji, the engulfing signal is another powerful indicator and you ignore it at your peril but there are three criteria that you must observe for the signal to carry significant weight and these are as follows. First the trend must be clearly defined, an uptrend for a bearish engulfing and a down trend for a bullish engulfing. Secondly the engulfing candle must enclose the body of the previous candle completely, but not necessarily the shadows. Finally the body of the second candle must be the opposite of the first and the only exception to this is where a doji candle is formed at a reversal point and then subsequently engulfed.
You will often come across the Western terms for engulfing candles and these are often referred to as inside or outside days. I prefer the Japanese terminology as it more closely describes what has actually happened in the market – in other words the bulls have been engulfed by the bears or the bears have been engulfed by the bulls. Either way this is a another powerful signal providing an early warning that we are about to see a possible reversal in the trend. The only market where we need to be more cautious with this signal is in the Forex market, as we rarely see windows in our candle charts where a price has opened higher or lower then the close on the previous day, so in general we must be more flexible in our approach, and provided the open and close are identical then we can still say that the engulfing principle applies.