Spotting price reversals and continuations is an important skill to master in the Forex market. Through price action analysis, traders can learn to use candlestick patterns to better navigate the market. Candle patterns can be a useful trading tool that can easily work into any active trading strategy. With this idea in mind we will focus on recognizing and trading one of the markets most clear cut price action signals, the bullish engulfing candle pattern.
What is a bullish engulfing pattern?
A bullish engulfing pattern is a candlestick pattern normally found at the end of a period ofdownward market pressure. Pictured above we can see the pattern itself which iscomprised of two completed candles. The first candle will depict the end of the currency pairs established weakness. The size of this primary candle can vary from chart to chart and is not directly pertinent to the engulfing pattern. Small candles such as dojis are considered preferable in this position though, as they can reflect market indecision in the current trend.
The second candle in the most important, which signals a return to a bullish market bias. This candle is expected to stick out from price action as a long blue candle creating newupward price momentum. To be considered a complete bullish engulfing candle, the high of this blue candle should close well above the high of the previous candle. The higher this secondary candle rises, the stronger our signal is considered. A new push of upward movement in this position on the chart, reflects new buyers overtaking the previous strength of the sellers.This actioncan be used in conjuncture with an established uptrend,with buyers looking to enter the market on new strength.
Learn Forex – EURJPY with Engulfing Patterns
(Created using FXCM’s Marketscope 2.0 charts)
Uses in Trading
Once you are familiarized with identifying the bullish engulfing candle pattern it can then readily be applied to your trading. Above is an excellent example of the pattern in action on a daily EURJPY chart. The EURJPY chart has moved as much as 2028 pips for the 2013 trading year. Along the way there have been price retracements against the trend, which concluded with the formation of a bullish engulfing pattern. These surges in price create new buying opportunities with the resumption of the long term bullish trend.
Once a bullish engulfing pattern is identified, traders had the option of considering a variety of trading strategies. While it is not uncommon to see traders execute on a candle pattern or price action alone, they can also be used in conjuncture with an oscillator such as RSI or a breakout strategy to give further confirmation of the reversal. The low of a bullish engulfing pattern can also be used as an area of price support in an uptrend. Regardless of the method chosen to pick a market entry, traders may choose to place stop orders under this price level in the event that the market retraces towards lower lows.
—Written by Walker England, Trading Instructor