ENGULFING PATTERNS

BULLISH ENGULFING Description

The Engulfing Pattern is a major reversal pattern comprised of two opposite colored bodies. The bullish Engulfing Pattern (Figure 2.21) is formed after a downtrend. It opens lower than the previous day's close and closes higher than the previous day's open. Thus, the white candle completely engulfs the previous day's black candle. Engulfing can include either the open or the close being equal to the open or close of the previous day but not both.

Criteria

• The body of the second day completely engulfs the body of the first day. Shadows are not a consideration.
• Prices have been in a definable uptrend, even if it has been short term.
• The body of the second candle is opposite color of the first candle, the first candle being the color of the previous trend. The exception to this rule is when the engulfed body is a Doji or an extremely small body.

Signal Enhancements

• A large body engulfing a small body. The previous day was showing the trend was running out of steam. The large body shows that the new direction has started with good force.
• When the Engulfing Pattern occurs after a fast move down, there will less supply of stock to slow down the reversal move. A fast move makes a stock price over-extended and increases the potential for profit taking.
• Large volume on the engulfing day increases the chances that a blowoff day has occurred.
• The engulfing body engulfing more than one previous body demonstrates power in the reversal.
• If the engulfing body engulfs the body and the shadows of the previous day, the reversal has a greater probability of working.
• The greater the open gaps down from the previous close, the greater the probability of a strong reversal.

Pattern Psychology

After a downtrend has been in effect, the price opens lower than where it closed the previous day. (See Figure 2.22). Before the end of the day, the buyers have taken over and moved the price above where it opened the day before. The emotional psychology of the trend has now been altered.

ENGULFING PATTERNS

BEARISH ENGULFING Description

The Bearish Engulfing Pattern in Figure 2.23 is a major reversal pattern comprised of two opposite-colored bodies. The Bearish Engulfing Pattern is formed after an uptrend. It opens higher that the previous day's close and closes lower than the previous day's open. Thus, the black candle completely engulfs the previous day's white candle. Engulfing can include either the open or the close be equal to the open or close of the previous day but not both.

Criteria

• The body of the second day completely engulfs the body of the first day. Shadows are not a consideration.
• Prices have been in a definable uptrend, even if it has been short term.
• The body of the second candle is opposite color of the first candle, the first candle being the color of the previous trend. The exception to this rule is when the engulfed body is a Doji or an extremely small body.

Signal Enhancements

• A large body engulfing a small body. The previous day was showing the trend was running out of steam. The large body shows that the new direction has started with good force.
• When the Engulfing Pattern occurs after a fast spike up, there will less supply of stock to slow down the reversal move. A fast move makes a stock price over-extended and increases the potential for profit taking and a meaningful pullback.
• Large volume on the engulfing day increases the chances that a blowoff day has occurred.
• The engulfing body engulfing more than one previous body demonstrates power in the reversal.
• If the engulfing body engulfs the body and the shadows of the previous day, the reversal has a greater probability of working.
• The greater the open gaps up from the previous close, the greater the probability of a strong reversal.

Pattern Psychology

After an uptrend has been in effect, the price opens higher than where it closed the previous day. Before the end of the day, the sellers have taken over and moved the price below where it opened the day before. The emotional psychology of the trend has now been reversed. (See Figure 2.24).