Engulfing Candlesticks

One of the most significant candlesticks is the engulfing candlestick. You can have long and successful trading career by simply trading engulfing candlesticks. In general, an engulfing candlestick is a very strong indication of a change in market sentiment.

To avoid making bad decision and benefit from that early indication of future market movements, every trader should find a way to incorporate engulfing candlesticks into his trading strategy.

What is an engulfing candlestick?

Candlesticks are especially useful to identify impending reversals. Although there are many reversal patterns, any professional trader can name at least 40 of them, the most important reversal candlestick pattern that any trader should know is the engulfing candlestick.

An engulfing candlestick signals the end of a movement. The engulfing candlestick has two main characteristics:

  1. The engulfing candlestick faces in the opposite direction than the preceding movement.
  2. The engulfing candlestick’s body is bigger than the body of the preceding day.

If a candlestick fulfills both of these criteria, it qualifies as an engulfing candlestick. The bigger the body of the engulfing candlestick is the more significant is the signal it creates.

Trading the engulfing candlestick

An engulfing candlestick indicates not only a change in market sentiment, but a, unusually strong change. While a price chart cannot tell you the exact reasons for this change, the engulfing candlestick tells you that, obviously, something must have happened. An event significant enough to cause such an abrupt, strong change in market sentiment is very likely to be significant enough to keep this new movement alive for at least the next periods.

In general, an engulfing candlestick indicates an impending reversal in the direction of the candlestick. A downwards engulfing candlestick after a preceding upwards movement indicates an impending bearish reversal. An upwards engulfing candlestick after a preceding downwards movement indicates an impending bullish reversal.

The simplest approach to trading engulfing candlesticks is to simply invest in a high / low option in direction of the engulfing candlestick once the engulfing candlestick is complete. In almost every case, the candlestick after the engulfing candlestick will point into the same direction.

For each consecutive candlestick, the effect of the engulfing candlestick becomes less significant. Therefore, you should keep your expiration time short, when trading such a strategy. In general, the shorter you choose the expiration time of your high / low option, the better.

Since the engulfing candlestick is likely to create a strong movement, you can also trade it with a touch option to generate a higher payout. In this case, you should combine the engulfing candlestick with an indicator that is able to predict the distance of the movement. In general, there are unlimited possibilities. However, the two most common possibilities are:

1) Using volatility indicators

By multiplying the value of volatility indicators such as the average true range] with the number of periods you expect the upcoming movement to last, you can calculate the distance the movement will cover, and whether a touch option is within reach of the movement. If it is, you should be able to trade a touch option with a relatively high winning percentage, enabling you to make a nice profit.2) Using standard-deviation indicators

Taking the approach of volatility based indicators one step further, some indicators use the standard deviation to automatically calculate realistic target prices, and resistance and support levels. The most commonly used indicator of this kind is bollinger bands.

As soon as an engulfing candlestick occurs, you can use bollinger bands to predict the range of the movement. If your broker offers you a touch option with a strike price within the reach of this movement and a realistic expiration time, you can expect to win this kind of investment often enough to make a nice profit with touch options

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