For those trading on forex it is essential to understand all the signals that the market offers daily. Technical analysis tools help the trader understand who is dominating the market: bulls or bears.
One of the most popular techniques are certainly the Japanese Candlesticks which, in addition to providing an immediate graphical feedback, are able to give forward-looking clues on the future price evolution.
Among the preferred price patterns we can find the so-called Engulfing Candles that can be both bullish and bearish.
The Engulfing bars are candles that show a greater top than the previous candle top and a lower low than the low of the previous candle; these candles are clearly represented with two different colours according to the bullish or bearish movement.
A bullish or bearish engulfing bar is in theory a sign of a possible reversal of the market trend. This pattern reflects the changes in the psychology of investors.
Bearish engulfing candle
The following chart represents the UsdJpy cross on a daily time frame. At the end of the uptrend we can see the bearish engulfing figure with the circled candle which, with body and tails, completely incorporates the previous candle. This figure at the end of a very strong uptrend is quite significant as bears have clearly won against the bulls.
The first important element is the key resistance level set for the following sessions. We can immediately find it by looking at the right side of the chart. In July and October, UsdJpy tried to overcome the top of the bearish engulfing pattern without success.
The second consideration is concerning the strategy. The best one is based on the short entry on UsdJpy when the low of the engulfing bar has been violated downward, setting a top as a stop loss.
In May the order was placed below the low of the engulfing figure, resulting in a very profitable short trade.
Bullish engulfing candle
The same figure can also be found in the opposite position, or on the market lows. In this case, a white candle like the one seen on AudUsd reverses the bearish trend by completely incorporating the previous black candle. The movement is even more significant because it allows AudUsd to return to an important level of support.
This strategy can be used on any time frame (weekly, daily, 1 hour, etc …). Clearly, the strength of these signals are amplified when the patterns show up near significant support / resistance levels.
