Engulfing pattern

Two candles, side by side. The first is small. The second is large and the opposite colour, and its body completely covers the body of the first.

That is an engulfing pattern. It says the side that was in control has been overwhelmed in a single session.

There are 2 versions. A big green candle swallowing a small red one is bullish. A big red candle swallowing a green one is bearish.

What matters is the body of the candle, not the thin shadows above and below it. The body is simply the gap between the open and the close.

Bullish engulfing (15.5.3). Formed when a small red candlestick is followed the next day by a large green candlestick, and the green body completely engulfs the previous day's red body. The workbook adds a strength test: these are "likely to signal reversals when preceded by four or more red candle sticks." Traders look not only at the 2 candles that form the pattern but also at the ones before them.

Bearish engulfing (15.5.4). A red candle completely engulfs the previous day's green candle. It "can occur anywhere but has more significance after a price advance."

What is measured. The workbook is explicit: "The real body — the difference between the open and close price — of the candlesticks is what matters. The real body of the down candle must engulf the up candle." Shadows are not part of the test.

Size and market conditions. Ideally both candles should be relatively long compared with the price bars around them. Two very small bars may technically create an engulfing pattern, but it is "far less significant" than when both candles are large. And the pattern "will have lesser significance in choppy markets and should be ignored" there.

Illustrative. Bullish case. A stock has closed lower for 5 straight sessions. Day 6 is a small red candle: open Rs 452, close Rs 446, a body of Rs 6. Day 7 opens at Rs 444 and closes at Rs 458 — a green body of Rs 14 running from Rs 444 to Rs 458, which fully covers the Rs 446 to Rs 452 body of day 6.

That is a bullish engulfing pattern, and because 5 red candles came before it, it clears the workbook's "four or more" strength test.

Bearish case. After a run up, day 1 is green: open Rs 980, close Rs 1,002 (body Rs 22). Day 2 opens at Rs 1,006 and closes at Rs 972 (body Rs 34), covering the whole Rs 980 to Rs 1,002 body. Both bodies are large relative to the Rs 8 to Rs 10 bodies of the surrounding sessions, so the pattern is significant rather than incidental.

Change one thing and it fails. If day 2 had closed at Rs 984, its body would run Rs 1,006 to Rs 984 and would not reach down past the Rs 980 open of day 1. No engulfing.

Chapters 15.5.3 and 15.5.4 (Bullish and Bearish Engulfing Pattern) treat the 2 directions separately. The workbook also names engulfing patterns twice outside that section: in 15.2.3 as one of the patterns a candlestick chart is best suited to identifying, and in 15.4.3 as a tool for analysing a tertiary trend.

Expect a question on what makes the pattern significant rather than on what it looks like: both candles long relative to their neighbours, 4 or more opposite-coloured candles before a bullish one, and the real body as the thing being measured.

• The real body engulfs, not the shadows. The workbook defines the real body as the difference between open and close, and says that is what matters. A candle whose shadow reaches past the previous candle is not enough.
• Two tiny candles can technically form the pattern and still be worthless. The workbook says so directly — far less significant than when both candles are large.
• In choppy markets the workbook says to ignore it. This is unusually blunt advice for a chart pattern and is worth remembering as written.
• "Four or more" preceding candles is the bullish strength test, not the definition of the pattern itself.
• Bearish engulfing "can occur anywhere." It is most meaningful after a price advance, but unlike Dark Cloud Cover it is not defined by its position in a range.