As we know, among all kinds of candlesticks that the market produces Engulfing candle is the strongest reversal signal. In this article, we are going to have a demonstration on this and learn how to trade based on an Engulfing candle.
Recently AUDUSD made an exemplary bearish move. That move was very technical, and I am pretty sure that the candlestick traders always look for getting this sort of chart setup.
Let’s have a look at the D1-AUDUSD chart.
On this chart, it was observed that the price got stuck within an up trending channel. To get a clearer picture, let’s zoom it in.
This chart provides us with a better idea about how the price was ranging within that up-trending channel. It might be noticed that the upper band was adjusted a little. A question might be raised here, how would we draw an up trending channel or adjust the line? Here is the solution. Flip over to the H4-AUDUSD chart and see how it looks.
It is the same drawn channel, but the price adjusted to the channel limits several times. It means that we have to flip over to an H4 chart to make an adjustment on the Daily chart for an up trending or down trending channel. Now that we have drawn our up trending channel let’s wait for the Daily candles to give us a clue where it might head to. Let’s flip over to the Daily chart again.
For a better view, I zoomed it in. Have a look at the last Daily candle. Yes, this is a Bearish Engulfing Candle. The wick of the candle covered the whole body of the previous candle, and it closed below the last candle’s lowest price. This setup is what made a strong statement that the sellers were going to get ready and took over the market from the buyers.
We had our first signal to go short on the pair. What would be the second one? The breakout had to be confirmed meaning the breakout level had to be maintained by the next daily candle. Eventually, the next candle was a Doji candle which was kept by the breakout level. It could have been another bearish candle as well or an Inside Bar.
Have a look at this
The very last candle came out as a Doji candle. This fact made a statement that the breakout was a confirmed breakout. After an Engulfing candle, if the next candle comes out as an Inside bar or a Doji candle, it is supposed to be a valid breakout. Shall we take our entry right away? Not really. Then, one of the most essential parts of the game had to be played. We again had to flip over to the H4 chart and wait for the next breakout.
Let us have a look
See the very last candle here. It came out from the support level which was held by the price of two consecutive trading days. As soon as the breakout H4 candle finished below that line, that was the signal to take the short entry.
Here are two more important things, setting Stop Loss and Take Profit. Stop Loss should be set all the way above that Engulfing Candles highest high, where the trend started. Regarding the Take Profit, there are several methods to be applied such as Fibonacci Ratio, Chart’s swing high or swing low or at the levels where the price reacted heavily earlier. We will learn those things eventually. It takes time and serious effort. However, in this case, one can easily have a risk and reward ratio of 1:1. It means the number of pips used to set the Stop Loss, could be applied to set the Take Profit as well.
To sum the whole procedure, first, we had to keep our eyes on the Daily chart and find what the price was doing. In that case, it was obeying an up trending channel. We had help from the H4 chart to draw it immaculately. We waited for a Daily breakout; then we waited for the breakout confirmation; then we flipped over to the immediate lower chart (H4 chart) to get the signal breakout. In this case to make a breakout at the previous lowest low which was achieved by the breakout and confirmation candles.
Do a lot of Practice
Does it sound too complicated? If it does, then have some practice by backtesting. Surely, it will get easier for you with practice. You might as well use the combination of H1 and H4 chart, 15M and H1 chart to do the backtesting.
Here we have demonstrated how an entry should be taken. As a trader, have you noticed how much patience and knowledge are required to take a good entry? Yes, it is not only about theory or knowledge, but it is a lot about patience. An investor often remains just an investor but never be a trader. To be a trader, one needs to have a serious level of patience, knowledge and experience to make most of it as far as trading is concerned.