Engulfing candle strategy: rules, a worked example and a free Pine Script

What an engulfing candle is

A bullish engulfing pattern is two candles. The first is bearish. The second is bullish, opens at or below the first candle's close and closes at or above its open, so its body covers the whole of the first candle's body. It says the sellers had the first candle and the buyers took all of it back, and more, in the second. A bearish engulfing is the mirror image.

In stock markets the second candle often opens with a gap. In forex, one candle usually opens where the last one closed, so the rule here is "opens at or below the previous close", not strictly below. The candlestick patterns guide shows the pattern next to 16 others.

Why location matters more than the pattern

Engulfing candles appear constantly, including in the middle of nowhere. The pattern means far more when it comes at the end of a pullback in an established trend: the trend is up, the price has dipped, and then one strong candle wipes out the last bit of selling. That's why these rules ask for three things besides the pattern itself:

• A trend. The price is above the 200 EMA for a bullish engulfing.
• A fresh low. The pattern makes the lowest low of the last 10 candles, so it's at the bottom of the pullback, not halfway down.
• A real body. The engulfing candle's body is at least half the ATR. A tiny candle that engulfs an even tinier one isn't saying much.

Many traders also like the pattern at a support level or after a liquidity sweep of a recent low; both are filters you can test by hand.

The rules, step by step

1. Check the trend

Longs only above the 200 EMA, shorts only below it.

2. Spot the pattern at the close

A bearish candle, then a bullish candle that opens at or below its close, closes at or above its open, and has a body of at least half the 14-period ATR.

3. Check the location

The lower of the two candles' lows must be the lowest low of the last 10 candles.

4. Enter at the close, stop below the pattern

Enter as the engulfing candle closes. The stop goes below the pattern's low, minus a quarter of the ATR. The target is twice the risk.

Worked example: GBPJPY, 1-hour chart

GBPJPY is in an uptrend and pulls back for about half a day. A bearish candle closes at 207.080. The next candle opens at 207.060, dips to 206.970, the lowest low in 10 candles, and closes at 207.490, above the bearish candle's open of 207.300. Its body is about 43 pips, well over half the ATR. With the price above the 200 EMA, that's a long signal.

The trend picks up again and the target is reached 17 hours after the entry. GBPJPY moves a lot, so its stops are often wider in pips than on EURUSD; the lot size takes care of that.

Risk management

• Size from the pattern. A big engulfing candle means a wide stop, so the position is smaller.
• One trade at a time. The script won't take a new pattern while a trade is open.
• Watch yen news. Bank of Japan decisions and talk of intervention can move yen pairs a long way fast.
• Check the swap. Holding GBPJPY overnight can cost or pay a noticeable amount; see the swap calculator.

Common mistakes

1. Trading every engulfing candle. Without the trend and location filters, the pattern is very common and much less meaningful.
2. Engulfing the wicks instead of the body. The classic pattern compares bodies.
3. Entering before the close. A candle can look like an engulfing halfway through and finish as something else.
4. Stops just under the low. The price often comes back to test the low. The ATR buffer gives it room.

Another candle-based setup with a clear stop is the inside bar strategy.

Backtest it yourself on TradingView

This page doesn't quote a win rate or a profit figure, and you should be wary of anyone who does without showing the test. Results change with the market, the dates, the data feed and the costs you put in. The honest way is to run the test yourself, and the free script below does the work in a couple of minutes.

1. Open the chart. On TradingView, open GBPJPY on the 1-hour chart.
2. Add the script. Open the Pine Editor from the Pine icon in the panel on the right of the chart (older layouts have it as a tab under the chart), delete the code that's already there, paste this strategy's code and click "Add to chart".
3. Put in your costs. Open the strategy's settings and go to Properties. Enter your broker's commission and a little slippage. A test without costs flatters every strategy, and short-term ones most of all.
4. Read the Strategy Tester. The panel under the chart shows the net profit, the maximum drawdown, the profit factor, the number of trades and a list of every trade. Click a few trades and check on the chart that each one follows the rules. Trade sizes are shown in units rather than lots: 100,000 units is one lot of a forex pair, and 100 ounces is one lot of gold.
5. Change one setting at a time. Compare the location rule on and off, the minimum body size (0.3 to 1 × ATR), the 10-candle lookback and the 2R target against 1.5R. Then try EURUSD, XAUUSD and the 4-hour chart.

As a rough guide, don't trust a result with fewer than 100 trades, a profit factor under 1 once costs are in, or a drawdown you couldn't sit through with real money. Settings tuned to look good on one stretch of history often fail on the next, so check the same settings on dates you didn't tune them on, then demo trade the strategy for a few weeks. How much history you can test depends on your TradingView plan: the free plan loads 5,000 candles, which is a few months of 15-minute candles but years of daily ones.

The script sizes each trade from the stop loss and your risk percentage, starts with $10,000 and assumes 1:100 leverage (a 1% margin setting), so the tester doesn't flag margin calls on normal forex trade sizes. Change these under Properties to match your account. By default TradingView fills orders at the open of the candle after the signal, so the fill can differ a little from the signal candle's close.

Download the free Pine Script and PDF

//@version=6
// Engulfing Candle strategy by PipLedger (https://pipledgerfx.com/engulfing-candle-strategy)
// Trades a bullish engulfing candle at a fresh swing low in an uptrend, and a bearish one at a swing high in a downtrend.
// Free to use and change. For education and backtesting only; not financial advice.
strategy("PipLedger: Engulfing Candle", shorttitle="Engulfing", overlay=true, initial_capital=10000, pyramiding=0, default_qty_type=strategy.fixed, default_qty_value=1, margin_long=1, margin_short=1, currency=currency.USD)

// ---------- Inputs
useTrend  = input.bool(true, "Only trade in the direction of the 200 EMA")
atSwing   = input.bool(true, "Pattern must make the lowest low (highest high) of recent candles")
swingBars = input.int(10, "Recent candles to check", minval=2)
minBody   = input.float(0.5, "Engulfing body at least (x ATR 14)", minval=0.0, step=0.1)
stopBuf   = input.float(0.25, "Stop buffer beyond the pattern (x ATR)", minval=0.0, step=0.05)
rr        = input.float(2.0, "Target (R multiple)", minval=0.5, step=0.25)
riskPct   = input.float(1.0, "Risk per trade (% of equity)", minval=0.1, maxval=5.0, step=0.1)

// ---------- Helpers
fx = strategy.convert_to_account(1.0)  // one unit of the chart's quote currency in account currency (1 on USD-quoted charts)
calcQty(float entry, float stop) =>
    float dist = math.abs(entry - stop)
    dist > 0 and not na(fx) ? strategy.equity * riskPct / 100 / (dist * syminfo.pointvalue * fx) : 0.0

atr    = ta.atr(14)
ema200 = ta.ema(close, 200)
patLow  = math.min(low, low[1])
patHigh = math.max(high, high[1])
lowest  = ta.lowest(low, swingBars)
highest = ta.highest(high, swingBars)

// bullish engulfing: a bearish candle, then a bullish candle whose body covers the whole of its body
bullEng = close[1] < open[1] and close > open and open <= close[1] and close >= open[1] and close - open >= minBody * atr
bearEng = close[1] > open[1] and close < open and open >= close[1] and close <= open[1] and open - close >= minBody * atr

flat     = strategy.position_size == 0
longSig  = flat and bullEng and (not useTrend or close > ema200) and (not atSwing or patLow <= lowest)
shortSig = flat and bearEng and (not useTrend or close < ema200) and (not atSwing or patHigh >= highest)

if longSig
    float sl = patLow - atr * stopBuf
    float q  = calcQty(close, sl)
    if q > 0
        strategy.entry("Long", strategy.long, qty=q)
        strategy.exit("Long exit", "Long", stop=sl, limit=close + (close - sl) * rr)

if shortSig
    float sl = patHigh + atr * stopBuf
    float q  = calcQty(close, sl)
    if q > 0
        strategy.entry("Short", strategy.short, qty=q)
        strategy.exit("Short exit", "Short", stop=sl, limit=close - (sl - close) * rr)

// ---------- Chart
plot(useTrend ? ema200 : na, "200 EMA", color=color.new(color.gray, 0))
plotshape(bullEng, "Bullish engulfing", shape.triangleup, location.belowbar, color.new(color.teal, 40), size=size.tiny)
plotshape(bearEng, "Bearish engulfing", shape.triangledown, location.abovebar, color.new(color.red, 40), size=size.tiny)
plotshape(longSig, "Long", shape.labelup, location.belowbar, color.teal, text="Buy", textcolor=color.white, size=size.tiny)
plotshape(shortSig, "Short", shape.labeldown, location.abovebar, color.red, text="Sell", textcolor=color.white, size=size.tiny)

Trading this from India

Residents can trade EURUSD, GBPUSD and USDJPY futures and options on NSE and BSE through a SEBI-registered broker. The contracts are quoted the same way as the spot pair, one lot is 1,000 units of the base currency, and they're cash-settled in rupees. They trade only from 9 a.m. to 7:30 p.m. IST, volumes are thin and not every broker offers them, so check the hours and the spread first. Trading forex or CFDs with offshore online platforms isn't allowed for residents under FEMA, even if the app is easy to download. Details are in is forex trading legal in India.

Related strategies: break and retest, inside bar, previous day high and low, liquidity sweep, XAUUSD pin bar, support and resistance bounce. All 34 strategies are compared on one page in forex trading strategies.