Putting Engulfing Patterns to the test and making some interesting distinctions along the way.

What is an Engulfing Pattern?  You may not be familiar with it, but for those who are familiar with these patterns of the Bullish and Bearish kind, it is a bit of confusing as far as defining what they are exactly.  In fact, there are as many as three different definitions for an Engulfing Pattern and much disagreement about the matter.  However, all that matter is whether the pattern is actually effective.   Dollars over Definitional Disputes.  All three definitions of Engulfing Patterns will be put to the test with three currency pairs.  Will they differ in results?

Defining the Engulfing Pattern

The Engulfing Pattern entails two candles, usually a shorter Candle that happened two periods ago and a longer candle that takes place a period ago.  The longer candle is supposed to overtake or engulf its previous candle and if it is of a bullish nature, the longer candle is bullish.  However, this is far too vague of a definition and it gets off the rails once one reviews the ways it is defined.

The Engulfing Pattern has three different definitions:

1. The longer candle’s body (no wicks) engulfs the entire previous candle.  The Open or Close is higher or lower than the high and low respectively.
2. The longer candle as a whole, wicks included, engulfs the entire previous candle.
3. The longer candle’s body (no wicks) engulfs the previous candle’s body (no wicks).

Engulfing Patterns used with Supply and Demand Concepts

A Supply and Demand indicator is used to help ensure the backtest takes place.

Long Entry

• Engulfing Pattern
• Low touches the Demand Zone
• The nearest Supply Zone Bottom is more than 40 pips away from the Close of the Previous Candle
• Ask Price is higher than the previous candle’s High

Long Exit

• Take Profit:  Close comes within 5 pips of the Supply Zone Bottom
• Stop Loss:  Close falls 15 pips below the Demand Zone Bottom

Short Entry

• Engulfing Pattern
• High touches the Supply Zone
• The nearest Demand Zone Top is more than 40 pips away from the Close of the Previous Candle
• Bid Price is lower than the previous candle’s Low

Short Exit

• Take Profit:  Close comes within 5 pips of the Demand Zone Top
• Stop Loss:  Close rises 15 pips above the Supply Zone Top

Whole Candle Engulfs Previous Whole Candle

EURUSD

USDJPY

AUDUSD

Whole Body Engulfs Previous Candle

Unfortunately, there were only two cases of a Whole Body of a candlestick engulfing the previous candle on a 1 Hour Chart within this particular trading strategy.  It is actually quite rare to see the Whole Body of a candlestick engulf an entire previous candle on a larger timeframe, but the smaller timeframes have more trading noise.

Whole Body Engulfs Previous Candle’s Body

EURUSD

USDJPY

AUDUSD

Conclusions to make about the Engulfing Pattern

Engulfing Patterns appear to work best when the entire candle fully engulfs the entire previous candle.  At least based on Price Action Supply and Demand Levels (which are a form of Support and Resistance), these are the conclusions to be made.  It is being used for the purposes of retracement and even reversal in these cases rather than continuation of a bear or bull rally.

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