The Engulfing Lights, using engulfing patterns as traffic lights

17th June 2017, 02:59 PM

There are countless candlestick patterns made of a simple candlesticks or a combination of several
Japanese candlestick patterns. Some of the names of these candles make a lot of sense, but sometimes
they can sound weird and somewhat ridiculous, for instance, dark cloud cover, three black crows,
abandoned baby, gravestone doji or the shaved bottom You could literally spend half your life
learning to identify these patterns on any price chart, you don't really need to do that since supply
and demand bases (pauses), valleys and peaks are made out of just a few of them: engulfing, piercing,
haramis, morning and evening stars. Read about these patterns in a previous lesson.

Out of all the Japanese candlestick patterns, I consider the engulfing pattern the most powerful one.
It's the building block of a trend, the trend created, the one that shows us if there is a balance or
imbalance at a certain area. Sometimes engulfing patterns fall short of closing above/below previous
candle's high or close, they end up being piercing patterns that fall very short of being engulfing
patterns (these are also very powerful patterns).

In this lesson we're going to go a step beyond and use the engulfing patterns as traffic lights.This is
why I've decided to name this lesson after the traffic lights and call it Engulfing Lights. We all know
what to do when we approach to a traffic light as a car driver. Green light? Keep on driving till the next
intersection. Red light? Stop the car, there will other cars or pedestrian crossing the street, you could
have an accident.

We will learn how to use engulfing patterns as traffic lights. These patterns will help us to have a more
mechanical approach as to where we want to buy or sell. Remember we're talking about probabilities
always, having an engulfing pattern does not mean price is going to behave the same way always, it
will help you look at the charts more objectively and expect what the market usually (not always) does
in these scenarios.

Supply and demand is made of price action, price action creates supply and demand.

DEFINITION OF AN ENGULFING PATTERN

What are engulfing bars? The engulfing bar formation consists of at least two candles, where the
second candle completely engulfs the previous one. The signal that the engulfing bar formation
provides is, depending on whether the second bar is bearish or bullish, either a reversal or a
continuation.

Engulfing patterns like all candlestick patterns have many different looks and as a rule of thumb an
engulfing pattern is defined as a candle that closes higher than the previous candle’s body high
(bullish engulf) or lower than the previous candle’s body low (bearish engulf). If it closes above the
high rather than above the body or below the low rather than below the body, then the engulfing
pattern will even be stronger. The candle that engulfs the prior candle shouldn't be a 50% candle.

24 hour markets like Forex Engulfing patterns can be slightly different to Stocks and Equities where
there is not so much liquidity and the markets are not opened 24 hours. Please bear that in mind.
There are dozens of books that deal with candlestick patterns, make sure you understand the
differences.
GBPJPY weekly charts show a few samples of engulfing patterns, both bearish and bullish

THE LOGIC BEHIND THE ENGULFING LIGHTS. ANTICIPATE

The logic behind the engulfing lights theory or scenario is very simple. If price has been rallying strongly
for let's say months, why is it that current monthly candle is stronger than previous monthly candle?
Why in a clear monthly uptrend with strong bullish ERC candles does a bearish engulfing candle
appears? Do you think this is normal behaviour in a clear uptrend? Yes, it is. For several reasons, after
a strong rally in price, many investors will close their trades since they are happy with their profits, the
end of a quarter may be near and long term investors are managing their portfolios, bad news for the
currency or stock, many reasons. Therefore, these patterns will give us a warning sign telling us "Hey,
you must buy but not this high, price is likely to retrace much lower, look for high odds demand level
to go long away, far away from current bearish engulfing pattern.

The engulfing patterns are telling us to expect a bigger retracement and when we stop trading in our
previous direction. We should resume the previous bias once price has retraced as we expect and
where we expected, usually at the opposing imbalance. The engulfing patterns are often accompanied
by piercing patterns, the engulfing + piercing is a very powerful combination, moreover when the
location and context is the right one (HTF in control).

Most of the scenarios you will see below have been covered in real time in the community as they were
happening.
A clear example can be seen now on Apple stock. Monthly candle hasn't closed yet (17th June 2017,
13 days left), but we must try and anticipate what could happen of the monthly bearish candle ends
up engulfing previous bullish candle after such a strong bullish move.

• Strong bullish move Apple's monthly chart with 3 bullish ERC candles creating monthly
demand at [1] price is losing steam now potentially creating a monthly bearish engulfing
pattern at [2] at the end of June when M candle closes.

• Note that last monthly impulse did not consolidate away, last bearish candle being slightly
strongly that previous M bullish candle. Lower timeframe's require confirmation. Read the
consolidation away lesson and why lower timeframe imbalances are negated if the HTF has
not consolidated away

• If M bearish engulfing is confirmed at [2] at the end of June, we should expect a bigger
retracement to a) origin of the move at [1] or b) the retest of all time highs at [4]. Apple stocks
are definitely too expensive to buy now
WHAT SIGNS WILL TELL US THAT PRICE IS PROBABLY CREATING A BIGGER RETRACEMENT?

• Strong impulse with 2-3 and more strong and explosive ERC candles (including failed ERCs).
After such explosive moves, price usually retraces to 50% of the move, HTF confluence, or the
origin of the move

• Over-extension one timeframe lower. If the strong rally happens on the monthly chart,
having one timeframe lower (Weekly) over-extended will help price to retrace to the origin of
the move since the Monthly interchange zones will be made of weekly CPs and CPs are low
probability after a very strong move

• HTF imbalance in control. If price rallied strongly and bumped into a HTF imbalance, seeing a
HTF bearish engulfing pattern tells us that the reaction is higher odds and a rebound of the
imbalance is mos likely to happen

• Nothing to the left. You look at the explosive move and there is no level on the left, both on
that timeframe and one timeframe lower

• No close above all time highs or HTF support/resistance. There are times when price can't
just close at all time highs/lows or a HTF resistance, every time price tries to break through it
it will snap back without closing and creating new engulfing patterns

• A bullish or bearish impulse has come to an end, expect a bigger retracement

WHERE WE SHOULD EXPECT THE BIGGER RETRACEMENT TO HAPPEN

• Retest of all time highs/lows break. Read #ALX stock analysis

• Previous opposing engulfing pattern, if any

 • Previous imbalance, as big as the timeframe where the engulfing pattern has been located

DON'T TRADE AGAINST ENGULFING PATTERNS

• Do not trade against brand engulfing patterns, expect a reaction from them, expect a bigger
retracement

• Wait for a bigger retracement and/or the removal of the engulfing pattern. If price has been
rallying for a long time and you get a strong weekly bearish engulfing pattern, don't take D1
or H4 demand zones against it, wait for a) bigger retracement down to opposing W bullish
engulfing pattern or W DZ b) the break of the W bearish engulfing pattern before taking any
longs

• See the engulfing patterns are big stones in a highway, you just can't drive into them

LOCATION AND CONTEXT IS EVERYTHING

Any candlestick pattern is useless if there is not a strategy behind it. When trading supply and demand
imbalances, multiple timeframe analysis, location and context are key elements in what we expect to
see. If price has been rallying for a long time, a monthly area of supply is reached in consolidation and
we see a Monthly or Weekly bearish engulfing pattern, what do you think is going to happen? Price
will start reacting to the M SZ. Both the location of the bearish engulfing pattern and the context
(consolidation and too high in the monthly range) are good, therefore the engulfing patterns will be
seen as the traffic lights turning red preventing us from taking any longs but giving us permission to
start looking for shorts.

SILVER IS TOO HIGH IN THE MONTHLY AND WEEKLY RANGES

• Location and context is everything.

• Brand new monthly supply created at [1], price fells short of retracing to nested weekly supply
at [2] and forms a weekly bearish engulfing at [3] with nested D1 supply zones

• Engulfing patterns are very powerful when the right context and location are met, in this case
M and W consolidation with new HTF supply zones created and HTF bearish engulfing patterns

• Too high in the M and W ranges, we should not buy, the engulfing lights turn red and tell us
that shorts is the only way we can trade
ENGULFING PATTERNS, HOW IT AFFECTS THE REALIGNMENT AND THE SEQUENCE
The core set and forget rules are based on the realignment and the sequence concepts. The engulfing
patterns can affect when price could start the process of retracing to one timeframe higher for
realignment with the bigger picture uptrend.

Having all three timeframes of our sequence in an uptrend and creating new bullish impulses, if we
start seeing engulfing patterns in the lowest timeframe of our sequence (D1), these patterns are
showing us signs of a bigger retracement and realignment at one timeframe higher, the weekly chart
at weekly demand. The same would apply on weekly bearish engulfing patterns expecting a bigger
retracement to monthly demand zones.

CADJPY WEEKLY REALIGNMENT EXPECTED TO HAPPEN AT WEEKLY DEMAND NESTED AT MONTHLY

DEMAND

• Strong rally on weekly chart with five weekly bullish ERC candles, these strong rallies are
usually unsustainable and price will stop dropping when reacting to a bigger timeframe
imbalance. Price usually retracing to the opposing imbalance or HTF bullish engulfing pattern,
like the one at [1] which happens to be a monthly DZ as well. W out of alignment, price
retracing to M DZ (one timeframe higher)

• The first sign will almost always be a Weekly bearish engulfing pattern, like the one at [2]. A
series of other bearish engulfing patterns or piercing patterns (dark cloud cover) can follow
suit like those at [3] and [4]. Then a new W bearish engulfing at [5] establishing another wall
that needs to be broken. Lots of room to reach the origin of the whole move at W DZ [1]

THE ENGULFING PATTERNS ARE OFTEN ACCOMPANIED BY PIERCING PATTERNS

This example was used above to illustrate how the engulfing patterns can affect the realignment and
the sequence. I will use it also as an example of engulfing + piercing patterns combined, they are a
very powerful combination, moreover when the location and context is the right one (HTF in control).

CADJPY WEEKLY ENGULFING + PIERCING PATTERNS

• Strong rally on weekly chart with five weekly bullish ERC candles, these strong rallies are
usually unsustainable and price will stop dropping when reacting to a bigger timeframe
 imbalance. Price usually retracing to the opposing imbalance or HTF bullish engulfing pattern,
like the one at [1]

• The first sign will almost always be a Weekly bearish engulfing pattern, like the one at [2]. A
series of other bearish engulfing patterns or piercing patterns (dark cloud cover) can follow
suit like those at [3] and [4]. Then a new W bearish engulfing at [5] establishing another wall
that needs to be broken. Lots of room to reach the origin of the whole move at W DZ [1]

After the engulfing pattern than happened at [1] we must wait for a bigger retracement to [2] but
sometimes price falls short of retracing to these areas but give us signs that it may possible not happen
by creating new engulfing patterns, like price action at [3]
JNJ STOCK MONTHLY BEARISH ENGULFING IN AN UPTREND

• After a strong rally in price on JNJ monthly chart, a monthly bearish engulfing pattern happens
at [1]. Expect a bigger retracement to previous M imbalance at [5] or HTF confluence, in this
case all time highs retest around [2]. M DZ [5] played out for some time and eventually failed
to hold

• After such a retracement two new M bullish engulfing patterns are created at [4] telling us
that previous bearish one at [1] is in jeopardy and there is high odds of having it removed.
New weekly demand is created on the weekly chart at [3]

• We can see how the weekly chart has created a new W bearish engulfing pattern at [6], expect
a bigger retracement, or the break of it before taking a long

FOOTSIE UK INDEX WEEKLY BEARISH ENGULFING PATTERN WITH OVER-EXTENSION

• Weekly bearish engulfing pattern after a strong rally in price creates resistance at [1]

• Price usually moves to the opposing engulfing on the same timeframe at [2], moreover when
there is over-extension on one timeframe lower (D1)

• D1 over-extension with several CPs. Aggressive bullish D1 TL broken

 EURAUD WEEKLY BEARISH ENGULFING AFTER A STRONG MONTHLY RALLY

• After a very strong rally in price on the monthly chart, monthly demand [1] was created, very
strong departure with 2 bullish ERC candles, we expect a bigger retracement.

• One timeframe lower, weekly, loses steam, last weekly bullish engulfing has no power to
consolidate away and the 'spring' of price is bound to snap back into place to the origin of the
move at [1] and [3]

EURCAD ENGULFING PATTERNS AT RESISTANCE, NO CLOSE

• Monthly is consolidating. Strong classic resistance at [1], monthly candles not having a single
close above. Weekly bullish engulfing patterns [2] after a very strong rally in price have no
power to consolidate away. This happens at M resistance [1] and strong W bearish candle at
[4]

• Expect price to retrace to the origin of the move at M DZ [3] and W DZ [3]
 EURSGD WEEKLY BULLISH ENGULFING PATTERNS NO CONSOLIDATING AWAY AFTER A STRONG
MONTHLY BULLISH IMPULSE

• Monthly is consolidating. Weekly bullish engulfing patterns [1] after a very strong rally in price
have no power to consolidate away. This happens very high in the weekly range near W SZ
and strong W bearish candle at [2]

• Expect price to retrace to the origin of the move at M DZ [3] and W DZ [4]

ADIDAS GERMAN STOCK. MONTHLY BEARISH ENGULFING AFTER A BULLISH IMPULSE

Adidas German Stock. After a very strong bullish move on the monthly chart with 2 bullish ERC candles,
steam is lost and a monthly bearish engulfing pattern is created at [1], this usually means that a bigger
retracement is expected to the origin of the move at HTF opposing monthly demand at [2] or opposing
monthly bullish engulfing which happens to be at the same place.
USDJPY BEARISH ENGULFING PATTERNS AFTER A STRONG BULLISH IMPULSE

After 2 strong monthly bullish ERC candles monthly demand [1] is created. Price usually retraces to
the origin of the move when these strong ERC candle are seen and previous trend was bearish. Right
after that explosive move on the monthly we see a monthly bearish candle at [4], this signals the end
of the move up and tell us we can expect a bigger retracement down to M DZ [1] and nested wide
weekly demand area [2]
USDSGD MONTHLY BEARISH ENGULFING AFTER A STRONG BULLISH MOVE

• Two monthly bullish ERCs followed by a monthly bearish engulfing pattern usually has price
retracing to the origin of the move. This happened at [2] after two consecutive M bearish
engulfing patterns, price returned to the origin of the move at [1] which originated at 2
monthly bullish ERC candles.

• The same is happening now at [3] and [4]. Strong bullish move with 2 monthly bullish ERC
candles at [3] and a monthly bearish engulfing pattern is printed at [4], expecting a
retracement to the origin of the move at [3].

• This bigger retracement did not happen a few months ago at [5], price fell short of retracing
to the origin of the move and retraced at the retest of the Monthly supply zone at [6], what
we used to call a flip zone

INTEL STOCK. MONTHLY BEARISH ENGULFING PATTERN AFTER EXPLOSIVE BULLISH MOVE

• After a strong explosive move with 3 monthly bullish engulfing patterns creating monthly
demand [6] monthly creates a bearish engulfing pattern at [1] that happens to break weekly
bullish trendline creating a new weekly supply at [2] which is made of a W bearish engulfing

• Price retests that supply and sort of engulfs again at [3] and continues to engulf on the weekly
at [4] and [5], all originated at monthly bearish engulfing at [1]. Price will usually retrace to
the origin of the move at M DZ [6]
PFIZER STOCK MONTHLY BEARISH ENGULFING AFTER STRONG BULLISH MOVE

• Monthly demand [2] was created after breaking all time highs, very strong bullish and
explosive move with several ERC candles. This usually means we should wait for a bigger
retracement

• After such an explosive move we can see a Monthly bearish engulfing pattern at [1] whose
bearish candle is stronger than previous bullish candle. This usually means the end of the
bullish move on that timeframe (monthly) and retracement to the previous opposing Monthly
engulfing pattern at [2] which happens to be Monthly Demand where we would be planning
our buy order at W DZ [3]

TRIP ADVISOR STOCK 3M BEARISH ENGULFING PATTERNS AND BIGGER RETRACEMENT

• Bearish engulfing patterns after a strong rally in price usually means end of the bullish move
and retracement to its origin.

• Trip Advisor was rallying strongly but at the end of 2014 there were two consecutive M bearish
engulfing patterns at [3] and [4] which also created 3M engulfing at [1]. It has been dropping
 ever since creating M bearish engulfing patterns from [3] to [8], providing a retracement lately
at W SZ [10] but missed [9]

NETFLIX. POTENTIAL MONTHLY BEARISH ENGULFING AFTER A STRONG BULLISH MOVE.

ANTICIPATING

• Netflix strong rally in price on the monthly chart, monthly bearish engulfing pattern being
created at [1] (anticipating what could happen), monthly candle is not closed yet but we must
try and anticipate what could happen in a couple of weeks

• Monthly candles preceding the bearish engulfing have no strength, that could help even more
in a bigger retracement down to monthly demand [2]. No matter what, with current price
action, potential bearish engulfing + weak rally in preceding candles it is not a good idea to set
and forget buy orders at weekly and daily demand zones between 149 and 135 (red dotted
lines)
NZDUSD 3M AND MONTHLY ENGULFING SIGNALS THE END OF THE MOVE

• Price dropped heavily from 3M bearish engulfing pattern at [12] and started to created a series
of 3M bullish engulfing patterns all the way up from [1] to [4] . The end of the move can be
seen with 3M bearish engulfing at [5] and again a strong retracement to no man's land created
another 3M bullish engulfing as the end of the bearish move at [6].

• The same can be seen on the monthly chart with M bearish engulfing patterns at [7, dcc] and
[8] and all of the sudden in no man's land a 3M bullish engulfing is created at [6] followed by
three consecutive M bullish engulfing patterns from [9] to [11]

NIFTY MONTHLY ENGULFING PATTERNS

• Engulfing patterns tell us if price is probably making a creating a retracement or not. Strong
monthly rally from M DZ at [4] these strong rallies are unsustainable, price loses steam at [1]
creating a bullish engulfing that does not consolidate followed by bearish engulfing at [2] and
[3].

• Where does price stop? At M DZ [4] creating a brand new M bullish engulfing pattern telling
us it will start rallying again.
RETRACING TO ALL TIME HIGHS RETEST INSTEAD OF DEMAND. ALASKA AIR #ALK MONTHLY BEARISH
ENGULFING
After a very strong monthly bullish impulse a monthly bearish engulfing pattern is created at [1], price
falls short of retracing to M DZ [2] and 3M DZ [3] and retraces to all time highs break retest at [4]

WATCH THIS MONTHLY VIDEO ANALYSIS ON AMERICAN STOCKS FOR APRIL 2018
This video shows dozens of examples on how the new engulfing patterns are telling us not to go long
against them because a bigger retracement is expected, it's too risky to trade against them

https://www.youtube.com/watch?v=vcHXSWxHQ1w