The Japanese technical analysis field has known a significant evolution recently (for the last two decades) as the Western world came in contact with new things to consider: Ichimoku cloud, candlestick theory, etc.
Under the Japanese candlestick techniques, reversal patterns are treated with respect as every trader wants to be warned when a trend is weakening or when it is reversing. Out of these reversal patterns, one is standing as being extremely common and powerful at the same time: bullish and bearish engulfing.
Judging by the name, a bullish engulfing reversal pattern appears when price is in a downtrend and signals a possible reversal, while a bearish engulfing reversal pattern appears when price is in a bullish trend and signals a possible end of the trend.
The engulfing pattern implies two candles (one bullish and one bearish in a bullish trend), and the second candle should engulf the previous one. A fifty percent engulfing when compared with the previous candle is considered to be sufficient but the higher the engulfing percentage, the stronger the pattern. The chart below shows a bearish engulfing pattern on a monthly EUR/USD chart and this shows why such reversal patterns are so powerful.
It is worth mentioning that bullish/bearish engulfings are valid on all the time frames, but it is more important as a reversal pattern the higher the time frame is. This is due to its significance and nothing else. If one is looking at an hourly chart and identifies an engulfing pattern, then the currency pair price may reverse for a while but after that the original trend resumes again which makes the engulfing pattern to be not that important. However by looking at the weekly, monthly, or even daily chart, such a pattern should set the pace for a longer period of time. Again the higher the time frame, the more probable the importance of the information such patterns offer. The chart below illustrates a bullish engulfing pattern on the hourly chart and you can see that while price reversed for a while, it came back and made a new low.
It should be considered all the time that the price is usually looking to test the lows / highs established by the bullish / bearish engulfing as a strong battle between bulls and bears is taking place at those levels. However such a reaction is not mandatory. After all this being a reversal pattern, it shows at least some weakness the previous trend has but the bulls / bears would not let the trend end that easy.
While the field of western world technical analysis takes into consideration head and shoulders, double bottoms/top, wedges, etc., as reversal patterns, it is worth taking into consideration Japanese candlesticks reversal patterns as they are only one more tool the trader has in fighting market randomness.
This article is written by John, webmaster of the forexbrokershub.com resource, which features detailed reviews of the most popular Fx brokers and more recently Binary Options brokers.