Candlestick patterns are the building blocks for candlestick charts and by extension, the field of technical analysis. In our dedicated article on technical analysis, we introduced you to these elements as well as the general ways in which they're used. Discover the typical building blocks of a candlestick pattern as well as two examples of a pattern in practice.
What makes up a candlestick pattern?
Every candlestick pattern starts with two or more candles, which are either shaded or unshaded or painted two different colors, depending on the trading platform that you're using. On NBX, for example, we show red and green candles, depending on the direction of an asset's price movements. That means that specifically, when an asset's price is going up, you'll see green candles, and when it's going down, you'll see red candles.
What time periods do candles typically represent?
As discussed in our article on technical analysis, each candle in a candlestick pattern represents a short-term period of trading like a day, or even an hour or minute, depending on what time period it's charted on.
For our purposes, as you read the below, consider each candle as representing a day of trading.
What is an engulfing pattern?
Candlestick patterns typically come in opposing pairs, which relate to bull and bear markets. Since an engulfing pattern is one of the most common pairings because of what it’s said to indicate, we’ve chosen to discuss it here.
Generally, an "engulfing pattern" is exactly what it sounds like.
When an asset experiences a negative day, followed by a positive day with a much wider range of price movement, then an engulfing pattern is generally said to have occurred.
Bearish Engulfing Pattern
A bearish engulfing pattern takes place when a positive day’s candle is engulfed by a much more negative day’s candle, as you can see below.
Generally, this pattern is said to signal more of a negative trend (a bear market) on the near horizon. As you can see, it consists of two candles, the first of which is a green(positive) candle, and the latter of which is a red(negative) candle. Given that the second candle is significantly larger than the first, and negative as opposed to positive, it is used as a signal that a bear market is on the horizon. Judging by historical technical analysis, this pattern can occur at basically any time and it's only used as a predictive signal when it happens in the middle of a bull market (significant price increase). If this is the case, then the bearish engulfing pattern has historically served as a reliable indicator that the market involved is about to reverse.
Bullish Engulfing Pattern
A bullish engulfing pattern, on the other hand, takes place when a negative day is engulfed by a much more positive day, as you can see below.
Just like with the bearish engulfing pattern, two candles are involved, though in this case, the first candle is negative, while the second is positive. If this pattern occurs during a bull market, then like the previous pattern, it's used as a reliable indicator that a market reversal is on the horizon.
How Traders Use Engulfing Patterns
In future articles here and on our blog, we’ll go into the opinions of traders on trading certain patterns like the engulfing patterns. For now, keep in mind that the longer the second candles are in both cases, the stronger of a case the pattern is said to be making for a market reversal. Additionally, this sort of indicator will always be confirmed with other trading tools, which we’ll dig into as the Knowledge Base evolves.
Before Relying on TA: Keep This in Mind
Just as with any trading tool, candlestick patterns are not meant as perfect indicators, especially not alone. The future's never certain and as a trader, it's important to have contingency plans for any sort of situation that might arise. Still with the knowledge you've gained here, you've got a foundation in how candlestick patterns are structured and what conclusions can be drawn from them. If you're interested in learning about more specific patterns, stay tuned for more technical analysis-related content here in the Knowledge Base.