The Formation of the Japanese Candlestick – The Bullish and the Bearish Engulfings
The Japanese candlestick techniques have become widely popular in all parts of the world mostly because Western technical analysis has included these techniques into their analytics. Japanese technical analysis has been used for many years in Japan and together with Ichimoku Kinko Hyo indicator, it has become present in all analytics techniques all over the world.
The principle of engulfing is also coming from Japan and as it has happened with many other techniques for the analysis, the western civilizations have embraced these techniques and they became an integral part of the analysis that is being used even today in all parts of the world.
The engulfing principle was created as the part of the Japanese candlestick technique and today, every binary option trading platform in the world is providing their clients with the opportunity to use this technique and to have the charts displayed in candles rather than in bars and straight lines like it was the case before the introduction of candlesticks. Because of that, being familiar with the candlestick technique give the advantage to the trader in the market. Among the most important reversal patterns that the candlestick charts offer to their clients is the pattern of engulfing. Like any other reversal pattern out there, the engulfing pattern can be bullish and bearish and it means that the bullish engulfing pattern will appear after the bullish trend and that bearish engulfing pattern will appear after the bearish trend.
Bearish and Bullish Engulfing
As it will be indicated in the recordings that will be provided in this educational material, the engulfing pattern is formed only with two candles. The bullish engulfing is formed by a very strong red candle that is followed by even stronger green candle while the bearish engulfing, on the other hand, is formed by a strong red candle. In this aspect, it is crucially important for the second candle to follow the same path that the previous candle has made and because of that this process or principle is called the engulfing principle. However, the question is, how can these issues be relevant for the trader when he or she is trading with binary options.
Before we go into the details, it needs to be mentioned that the higher the time frame is for such a pattern, the pattern will be stronger. Consequently, we can conclude that it is more important and in fact, better when the engulfing appears on the daily chart rather than on the hourly chart or even on the chart with smaller time frame. Additionally, this pattern is almost always followed by the bulls (when it comes to the bearish engulfing) that are trying to return to the previous highs (trader needs to remember that the bullish engulfing appears after bullish trend) and because of that trader should be looking for a level of retracement of minimal 50 percent in comparison to the red candle. In this situation and with such levels of retracement, this is actually the best moment for a trader to buy the put options as well as to determine the date of expiration that is based on the time frame in which the pattern is appearing.
Besides that, when it comes to the bearish engulfing pattern, what a trader needs to do is to wait for a level of retracement to reach 50 percent on the green candle and when that happens that will be the movement when trader can buy call options with the date of expiration that is determined on the basis of the time frame in which the pattern is formed. As we have mentioned at the beginning of this article, the engulfing is characterized by two candles where the second candle engulfs the first one.
Identification of the Insights from the Engulfing
In order for the process of engulfing to happen, the first candle needs to be completely engulfed which means that in the majority of cases the second candle initiates the gap in a position higher than a bearish engulfing point or with the gap that is lower that the bullish engulfing point is. However, there is one catch with all of this. Since the engulfing are being characterized as the reversal patterns, they indicate the fight that is occurring between the bulls and the bears that is actually taking place in those candles.
Because of that, in the case of bullish engulfing pattern, the bears will not surrender that easily and they will try to resist by pushing the prices lower and in that case, they will attempt to take the lows from the first candle. If it happens that the patterns are being formed on the smaller time frames such as five-minute charts or even an hourly chart, it means that the patterns will hardly survive.
The main reason for that is the fact that the issue of binary options trading is today regulated by the HFT or the High-Frequency Trading as well as the algorithmic trading (that are actually robots that are programmed in that way that they can detect certain patterns) and these bullish as well as the bearish engulfing are both included in the pattern of recognition trading.
For Longer-Term Trading Engulfing Patterns are Better Solution
With this being said, it is also very important to mention that there are more possibilities that the option will expire in money in the cases if the engulfing patterns are appearing on the daily, weekly or even on the month chart basis instead of on the basis of smaller time frame charts.
Because of that, it is very important to determine the date of expiration and in doing so traders would have to even think about the end of the month for that purpose. The main reason for that is the fact that when selecting that date expiration there is no mandatory wait of one month. If the trade is conducted in the second part of the month, traders will have to wait less than two weeks instead of one full month. Considering everything, waiting two weeks is not that big problem.
Even in these cases, many traders will find themselves in situations in which it will be very hard for them to find the best striking price.
Once again, one of the most crucial things for success in this regard is the Fibonacci retracement tool and the measurement of the entire length of the entire engulfing pattern as well as buying put options on the retracement with the level at 61.8 percent in bearish conditions and buying call options in bullish conditions.
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References and Further Reading:
- A modern neural network model to do stock market timing on the basis of the ancient investment technique of Japanese Candlestick (Milad Jasemi, Ali M. Kimiagari, A. Memariani)
- Hybrid approach to the Japanese candlestick method for financial forecasting (Takenori Kamo, , Cihan Dagli)
- Candlestick Charting Explained (Gregory Morris)
- Wrapper ANFIS-ICA method to do stock market timing and feature selection on the basis of Japanese Candlestick (Sasan Barak, Jalil Heidary Dahooie, Tomáš Tichý)
- Are candlestick technical trading strategies profitable in the Japanese equity market? (Ben R. MarshallEmail , Martin R. YoungRochester Cahan)