ReversalHeuristic1 min read
◆ The PatternThe second candle swallows the first — momentum shift
An Engulfing pattern is a two-candle reversal. Bullish: small red candle followed by a larger green candle that completely covers the red body. Bearish: small green followed by a larger red that engulfs it.
Second body completely covers (engulfs) the first body
The engulfing candle shows conviction — the larger the second candle relative to the first, the stronger the signal.
// Bullish and Bearish Engulfing
Key insight: Engulfing patterns at key support/resistance levels are far more significant than those in the middle of a range.
Pattern bridge: One candle completely contains the prior — a variance expansion in a single bar.
Worked example
Yesterday was red, from 102 down to 100. Today opens at 99.5 and closes at 102.5: its body covers yesterday’s completely. A bullish engulfing pair.
The example data
The bars the example is worked on.
| Bar | Open | High | Low | Close |
|---|---|---|---|---|
| 1 | 103 | 103.5 | 101.5 | 102 |
| 2 | 102 | 102.5 | 99.5 | 100 |
| 3 | 99.5 | 103 | 99.2 | 102.5 |
Where it misleads
- It depends on gaps between sessions, so it is common on daily stock charts and rare on round-the-clock markets, where each open is the previous close.
- After a long decline it reads as a reversal; inside a range it means little.
- The evidence for one- and two-bar candle signals is weak (Marshall, Young & Rose 2006).
In code
(o1, c1), (o2, c2) = df[['open', 'close']].iloc[-2], df[['open', 'close']].iloc[-1] bullish = c1 < o1 and c2 > o2 and o2 <= c1 and c2 >= o1 # today's body covers yesterday's
Assumes import numpy as np, import pandas as pd, and a DataFrame df with columns open, high, low and close for the data above.
Sources
- Japanese Candlestick Charting Techniques, S. Nison, New York Institute of Finance, 1991
- B. R. Marshall, M. R. Young & L. C. Rose, “Candlestick technical trading strategies: Can they create value for investors?”, Journal of Banking & Finance 30(8), 2006 — they found none on Dow Jones stocks
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