Japanese candlestick techniques are used on a world wide basis now as the Western technical analysis branch has embraced them full heartily. Japanese technical analysis are using them for ages and together with the now famous Ichimoku Kinko Hyo indicator, they made Japanese technical analysis famous all over the world.
The engulfing principle comes from Japan and, like many other technical analysis notions from that part of the world, the Western technical analysis branch quickly adopted and it is extremely used now.
The engulfing principle is part of Japanese candlestick techniques and every trading platform in the world is offering now the possibility of having the chart displayed in candles and not only bars or straight lines. Therefore knowing these techniques offers a competitive advantage in front of markets. One of the most important reversal patterns coming from the candlestick charts is the engulfing pattern. Like any reversal pattern, it can be either bullish or bearish, meaning a bearish engulfing will appear after a bullish trend and bullish engulfing appears after a bearish trend.
Bullish and Bearish Engulfings
Like the recordings that come with this educational material show, such a pattern is being formed only out of two candles: bullish engulfing: strong red candle followed by an even stronger green candle; bearish engulfing: strong green candle followed by a powerful red candle. It is mandatory for the second candle to totally retrace the previous candle’s body, and this represents the engulfing principle. However, how can these be useful when trading binary options?
First of all, it should be mentioned that the higher the time frame such a pattern is identified, the strongest the pattern, meaning it is more important that the engulfing appears on the daily chart for example than if it is appearing on an hourly chart or lower.
Second, almost always this pattern is followed by the bulls (in the case of a bearish engulfing) trying to take the previous highs (remember that the bullish engulfing appears after a bullish trend) and therefore at least 50% retracement level when compared with the red candle should be looked for. Therefore in this situation buying put options when the 50% retracement of the red candle is touched would be the appropriate thing to do and the expiration date to be choose based on the time frame the pattern appears.
On the other hand, in the case of a bearish engulfing pattern, the thing to do is to wait for the 50% retracement level measured on the green candle and at that level to buy call options with the expiration date to be considered based on the time frame the pattern appears.
Like mentioned at the beginning of this educational series project the engulfing is represented by two different candles and the second one is engulfing the first one.
Identifying the Insights from Engulfings
In order for the engulfing to take place, all of the first candle needs to be engulfed, and this means that most of the times the second candle starts with a gap higher in a bearish engulfing scenario or with a gap lower in a bullish engulfing one. But there is a catch. As they are being interpreted as reversal patterns, they show a terrible fight between bulls and bears that is taking place in those two candles.
This means, for example in a bullish engulfing pattern, that bears will not give up fight that easy and will try to push prices lower and take the lows in the first candle. From my experience, if the pattern is forming on the lower time frames, like on the 5 min chart or the hourly chart, then it is rarely surviving.
The reason for that comes from the fact that trading nowadays is governed by HFT (high frequency trading) and algorithmic trading (robots or algo’s that are programmed to recognize specific patterns) and bullish or bearish engulfing are incorporated in pattern recognition trading.
Engulfing Patterns are Better Suited for Longer-Term Trading
That being said, there are more chances that an option will expire in the money if the engulfing pattern is appearing on a daily, weekly or monthly chart, rather than on a lower time frame.
For that, we need an appropriate expiration date and we may even consider end of month. By choosing such an expiration date there is not mandatory to wait one month. If the trade is taken in the second half of the month then it is actually a waiting time of less than two weeks. Taking into account the big return on investment binary options trading is offering then waiting two weeks should not be a problem.
Even in such cases, when engulfing is happening on the bigger time frames, finding a striking price is difficult.
One key to success is to take a Fibonacci retracement tool and measure the length of the whole engulfing pattern and buying put options on a retracement into the 61.8% level in a bearish engulfing or call options in a bullish one.