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Introduction

The engulfing pattern also known as "hugging line" is probably one of the most popular candlestick patterns. This pattern consists of two candles. There are two major characteristics for this pattern.

• The direction of the candles is opposite to each other. For example if the first one is bearish then the second one is bullish. The first candle could be a doji, a spinning top, or any other candle type. The second candle, however, cannot be a doji. We also prefer to see a long real body for this candle.
• The real body of the second - the most recent - candle covers the real body of the first - the older - candle. For example if the first candle is bullish and the second candle is bearish then the open of the second candle is either higher or equal to the close of the first candle. Also the close of the second candle is either lower or equal to the open of the first candle. The high or low of the candles are not important.

The following image shows an example of an isolated engulfing pattern.

The Engulfing Pattern as a Reversal Sign

An engulfing pattern appears on a Forex chart quite often. Nonetheless, it becomes important only when it shows signs of reversal. If the second candle is a bullish candle and the pattern appears at the bottom of a downtrend then this pattern could be sign of reversal from a downtrend to an uptrend (see image).

If the second candle is bearish and this pattern appears on top of an uptrend then it could represent reversal to a downtrend (see image).

There are some occasions that this pattern could appear as a continuation pattern both in uptrend and downtrend. You may consider the following to filter out some false patterns.

• If the first candle has a short real body - such as a spinning top - and the second one has a relatively long real body then this pattern could be more reliable.
• If the pattern appears after a sharp move then it could be more reliable. You may use CCI - Commodity Channel Index - or another indicator to see whether you are dealing with a sharp move or not.
• You may also use a moving average with a short period such as 10 or lower to confirm the existence or significance of the trend. If a trend does not exist or has recently shown a correction then the pattern is very likely to be misleading.

Locating Engulfing Patterns on a Candlestick Chart

Locating a general engulfing pattern on a chart is relatively easy. All we need to do is to locate a candle that its direction is opposite to its previous candle and also its real body covers the real body of the previous candle.

To locate bullish and/or bearish engulfing patterns I had to make a few other assumptions. For a bullish pattern I have considered the following.

• The low of the first candle is lower than the low of its previous candle.
• The low of the second candle is lower than the low of its next candle.

To locate bearish patterns I have considered the following assumptions.

• The high of the first candle is higher than the high of its previous candle.
• The high of the second candle is higher than the high of its next candle.

This approach is somewhat similar to how we define Fractals in a chart. The result looks like the following image.

If a pattern does not meet the conditions for bullish or bearish patterns then it is a neutral pattern. In other words it does not represent a reversal formation. The indicator shows an arrow on the second candle to not only locate the pattern but to specify the new direction of the trend.

Since this method compares the pattern with two other candles only, it could sometimes suggest a pattern as bullish or bearish reversal while the actual trend is not a downtrend or an uptrend respectively. To remove noises from this indicator you may add a moving average or draw a trend line.

Download "Engulfing Pattern" Indicator [download]

Click here to download the compiled version of this indicator. I have designed the indicator for MetaTrader 4 (MT4). If you are not using the latest build of MT4 then you may encounter technical problems. Click here for more information and possible solutions.

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Previous Candlestick Lessons:

Lesson 01: An Introduction to Candlestick Charts

Lesson 02: Umbrella Lines - Reversal

Lesson 03: Doji Candles - Part 1

Lesson 04: Doji Candles - Part 2

Lesson 05: The Spinning Top Candle