How to Trade the Bullish Engulfing Pattern

10/15/2012 9:00 am EST

Focus: FOREX

Walker England of DailyFX.com shows how to recognize and trade one of the market’s most clear cut reversal signals.

Spotting price reversals is one of the most difficult actions to master in the forex market. Through chart analysis, traders can learn to identify candlestick patterns that are a natural tool for this task. Candle patterns can give visual insight into market psychology and can suggest changes in sentiment, which is useful in finding a market reversal. With this idea in mind we will focus on recognizing and trading one of the market’s most clear cut reversal signals, the bullish engulfing candle pattern.

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What is a Bullish Engulfing Pattern?
A bullish engulfing pattern is a candlestick pattern normally found at the end of a downtrend. Pictured above the pattern is created by interpreting the data of two completed candles. The first candle will depict the end of the currency pairs’ established weakness. The size of this primary candle can vary from chart to chart and is not directly pertinent to the pattern itself. Small candles such as dojis are considered preferable in this position though, as they can reflect market indecision in the current trend.

The second candle is the most important candle of the pattern and is considered the actual reversal signal. This candle is comprised of a long blue candle creating new upward price momentum. Ideally the high of this candle should extend well above the high of the previous candle. The further this secondary candle rises, the stronger our signal is considered. A new push of upward movement in this position on the chart, reflects new buyers overtaking the previous strength of the sellers. This action often precedes a continued rise in price with buyers looking to enter the market on new strength.

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Uses in Trading
Once you are familiar with identifying the bullish engulfing candle pattern it can then readily be applied to your trading. Above is an excellent example of the pattern in action on a daily EURGBP chart. From June 11 through July 20, the EURGBP declined as much as 401 pips. This descent in price concluded with the formation of a bullish engulfing pattern. This was our first opportunity to consider new buying opportunities prior to our current run up in price seen above. Once a bullish engulfing pattern is found, traders had the option of considering a variety of entry mechanisms to place new positions. While it is not uncommon to see traders execute on a candle pattern alone, they can also be used in conjuncture with an oscillator such as RSI or a breakout strategy to give further confirmation of the reversal. The low of a bullish engulfing pattern can also be used as an area of support. Regardless of the method chosen to pick a market entry, traders may choose to place stop orders under this price level in the event that a bullish reversal fails and a lower low is made.

Walker England is a trading instructor at DailyFX.com.

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