A trend is headed up followed by a short white body and a small trade volume. The next day, after the opening price takes a new high, the prices plunge rapidly. The price drop is accompanied by large trade volumes. As a result, the closing price turns out to be lower than the opening price of the previous day. On the emotional level, the upward trend is considered to be broken. If the prices remain low on the third day, a major reversal of an upward trend appears. An opposite scenario unfolds in the Bullish Engulfing pattern.
If the real body of the second day engulfs both the body and the shadows of the first day, then the pattern has growing importance. The color of the first day reflects the market trend. When a trend is upward, the body of the first day is colored white, and when a trend is downward, the body is colored black. The color of the second, i.e., engulfing day has to be of the opposite color. Engulfing suggests that any part of the body does not match or goes beyond the opening and closing prices of the real body of the second day. If the real body of the first day is at least 30 per cent shorter than the one of the second day, it indicates that a stronger pattern appears on the chart.
The Bullish Engulfing pattern forms a Paper Umbrella or a Hammer which signal a pivot point of the market. The Bearish Engulfing resembles a Shooting Star or more likely a Gravestone Doji when the body of the candlestick is extremely short. Both bearish and bullish patterns come down to a single candlestick which fully encourages their merging.
The Engulfing pattern is also the first two days in the Three Outside Days pattern. The Bullish Engulfing pattern can become the Three Outside Up pattern when the closing price of the third day is higher. Similarly, the Bearish Engulfing pattern can become the Three Outside Down when the closing price of the third day is lower. At the same time, the Engulfing pattern is the next stage of the Piercing Line and the Dark Cloud Covers. That is why the Engulfing pattern is of major importance.