Absorption candlestick pattern in Forex - a reversal pattern in trading

Hello, friends!
We continue to study methods and patterns of Forex trading using Price Action. This time we will talk about Absorption Models (another name for the Outside Bar), which is very similar to the Inside Bar, but the signal and preceding candle in Absorption Models as if their places have been swapped. Watch the video and you will understand everything yourself.

Absorption Pattern 2.0 - how to trade the Price Action pattern

In this article we will analyze the Price Action engulfing pattern - one of the main candlestick patterns, which traders value for its reliability and high percentage of signal processing. Confirmed by other factors (key levels, indicator signals, fundamentals), an engulfing pattern can become an effective tool for making a profit.

What is an absorption pattern?

An engulfing pattern is a trading model of Price Action candlestick analysis in the foreign exchange market and indicates a change in price direction.

When using the formation, you can find the best entry points during the end of the correction or when the trend changes.

Absorption is characterized by a high level of signal processing and reliability . And the name of the candle structure is due to the fact that the first candle is absorbed by the second.

A trading pattern, also known as an outside bar , is often used to identify a trend reversal point. Less commonly, it indicates a continuation of global price movement. Externally, absorption consists of two candles (white and black, or red and green), directed in different directions - the first is smaller, the second is larger.

The article talks about how to trade, what it consists of, reasons for its formation and main indicators.

Filters

As a rule, traders ignore the engulfing pattern if it appears during a price flat in a small range, since the probability of the setup being worked out is much lower than during a trend.

Sometimes there are situations in which the engulfing candle is abnormally large. If you see on the chart the formation of an engulfing pattern that meets all the rules, but the size of the signal bar is several times larger than the series of previous candles, then it is better to ignore such a signal. Firstly, the stop loss size will be unreasonably high, and secondly, a strong price movement is usually followed by a correction. It is much more profitable to take signals indicating the end of a correction in the direction of the trend than signals against the trend in the hope of a correction. This applies to all price action setups.

Reasons for absorption in trading

An engulfing pattern appears after a long price movement in one direction . That is, the reason for the formation is the exhausted potential of the trend.

If we look at this pattern from the point of view of the crowd, then the fading price movement indicates the uncertainty of a large mass of small traders. Speculators do not know in which direction to open trades next. As a result, the value of the asset begins to stagnate.

At the same time, the positions of major players form a new direction of movement - a large engulfing candle. They are the first to realize that a new trend is starting and accumulate a position. Small players catch stop losses or follow the updated movement of the asset.

For example, if the price of an instrument stopped declining, then the bears encountered a strong support level. At the same time, downward orders were opened when the downward direction remained due to the inertia of the currency pair.

At this point, the bulls can open a large volume of trades in the opposite direction, collect the stops of the bears and knock them out of the market. Collected stops will push the price further up.

This is how a new upward trend is formed. This principle also applies during a downward reversal, when the bullish movement loses its strength.

Logical component

Every pattern has its own logical foundation, and the absorption pattern is no exception. The market, having formed this pattern, indicates certain processes on it and indicates a higher probability of the price continuing to move in the same direction as the engulfing candle. The logical meaning is based on the concept that market participants are still undecided about buying and selling or are inactive on the preliminary candle, but subsequently demonstrate the strength of bulls or bears acting more aggressively on the engulfing bar. Thus, there is a higher probability of continued price movement towards stronger market participants. This explanation of the price pattern may seem simple, but an experienced trader by observing this pattern can gain a significant trading advantage and a chance to join stronger market participants.

Let's imagine that the market is experiencing a correction in an uptrend, and a small bearish candle appears, confirming the continuation of the correction. Then, on a new candle, the price first continues to move down, activating pending sell orders for those who want to make money on the correction. Then, on the same candle, traders begin to buy, expecting the trend to continue, the price reverses and closes above the previous candle, knocking out the stop losses of selling traders and introducing them into losses. Thus, a bullish engulfing pattern has formed. Seeing this situation, traders expecting a resumption of the trend join purchases, and those who sold at the beginning of the correction also fix their profits and enter purchases. This is how the bullish mood has returned to the market and provides an excellent opportunity to make money on it.

Varieties of engulfing pattern in trading

There are two main types of absorption model :

  1. Bullish engulfing. In this formation, the larger candle is the one pointing upward . The trading structure is located at the end of a pronounced downtrend . It indicates that the bulls are taking power away from the bears and provides an upward reversal signal.
  2. Bearish engulfing. In the pattern, the second downward candle is the larger one . The pattern is formed at the end of a strong bullish trend . Indicates the victory of buyers over sellers with a selling entry point.

The significance of the pattern will be higher if the new candle absorbs not only the body of the previous one, but also the shadow. In intraday trading, the closing price of the first bar and the opening of the second may be the same.

If, when an absorption is detected, you move to a higher time range, you can see a pin bar. The equality of the first and second candle on the next TF represents a doji candle.

Strengthening factors

FIGURE 4 The engulfing model, both bearish and bullish, needs to rely on support/resistance levels, these can be price levels, fibo levels, and so on.
If we take all the absorption models, then such trading is unlikely to be profitable. FIGURE 5 Examples of bullish and bearish engulfing patterns The important point is that the body of the second candle must engulf the first candle. For example, if an engulfing candle looks like a doji, as in Figure 4, then this tells us that neither the bulls nor the bears, despite their aggression, were able to dominate, and it is better to refrain from such a pattern. It is also possible that one of the shadows of the inner candle will not significantly extend beyond the outer bar; this can also be considered an absorption model, but will be a weaker signal. From this we can conclude that the main thing is that the engulfing candle stands out significantly against the background of the engulfed bar. FIGURE 6 Formation of an engulfing pattern before correction. A signal-strengthening factor is the presence of a strong bullish or bearish trend movement before the formation of the pattern. The formation of an engulfing pattern immediately after reaching a new maximum or minimum in the opposite direction indicates that the trend strength is running out and there is a possibility of a correction or trend reversal, as in Figure 6. It should also be noted that the engulfing pattern shows the best results when trading on trend. Sometimes reversal patterns work out quite well, but it is best to enter after corrections in the direction of the main trend.

Bullish engulfing and its features

In the pattern, the body of the bullish bar completely engulfs the bearish one. Let's consider the daily timeframe model and evaluate it according to the following criteria:

  • A downward trend is easily recognized on the chart .
  • On the first day, a small bearish candle with small shadows is formed.
  • On the second day, the opening price of the new outside bar may be lower (higher) than the closing price of the bearish one . There may be a noticeable price gap.
  • The formed bullish candle completely covers the body of the bearish one . The asset price closes significantly above the border of the bearish bar – 25% of the entire range.


With bullish engulfing, the volumes of the bearish trend should decrease noticeably . This pattern indicates that the bulls are warming up before moving the asset in the opposite direction.

Entry at 50% retracement

I like to use the 50% retracement entry method. Many traders believe that this entry method only works with pin bars. However, it can also be used when trading the engulfing pattern.

Here's an example of the same trade setup, only this time I've used Fibonacci levels to mark the 50% level:

The 50% level was found by dragging a Fibonacci extension from the outer bar's low to its high.

Another example for a bearish engulfing pattern:

In the 4-hour chart above, we are entering the market at the 50% retracement of the bearish engulfing candle that formed on the daily time frame. The highs and lows you see in the chart above represent the daily range of the engulfing candle.

Although I like to use the Fibonacci tool in this manner, I never use it as a replacement for key support and resistance levels. It is the levels that should primarily determine our entry and exit points from the market.

Features of bearish engulfing in trading

The pattern is formed when the bullish trend fades . At the very top of the D1 time period, a small white candle appears . The next day a black one forms . The minimum of a black candle is lower than that of a white candle, and the maximum is higher. As an additional signal to enter the market, you should use a rebound from the trend line. The longer the pattern's candles, the higher the reversal potential.

When an upward candle is formed, trading volume should decrease, and when a bearish movement begins, it should increase.

Signal Boost

In the absence of amplifying elements, the signal may be false. Consider the following market factors:

  • There is a big difference in the size of the candles in the model . The larger the second candle and the smaller the first, the stronger the reversal signal.
  • Absorption of several previous candles. When a reversal outside bar turns out to be larger than several previous ones, it makes sense to expect a change in trend.
  • Candles without shadows are the most suitable option.
  • The emergence of a pattern during a prolonged trend. The longer the price moves in one direction, the fewer people want to open positions along the trend. That is, large players who are already in the market are beginning to take profits.

    If there was a sideways movement before the appearance of two bars of the formation, the signal is not counted.

  • Increase in volume when the second candle is formed . This means an increase in the activity of players opening transactions in a new direction. This behavior of traders strengthens the signal received from the structure.

Selected cases of takeover

You can find interesting situations in the market - sequential absorption, consisting of several candles. That is, it turns out like this:

  1. The engulfing pattern is formed in its usual form, that is, the trend reverses and its first candle completely covers the range of the last trend candle.
  2. After this, a new candle appears, which forms an absorption with the previous one. That is, in fact, we have formed a model of trend continuation.

It is difficult to call this a true continuation of a trend, since such candles do not appear out of nowhere. At the same time, they are processed with a fairly good probability. The most reasonable option in this case would be to simply observe what is happening. If a trader initially stood in a position following the trend and did not exit after the first absorption, then there is no need to take any action. If there was an entry and a stop was placed on it, then you should stay out of the market, since the new takeover may not work out and in this case there will already be two negative transactions. Considering that it would be wrong to consider such absorption as a full-fledged model and add it to the statistics, it is better to simply skip it.


Example of double absorption

Another option is a triple takeover in a row . That is, candles are drawn, each of which overlaps the body of the previous one. This is an extremely unpleasant situation for those who trade each of the models. It is precisely because of the likelihood of such a market situation that it is not recommended to enter into a second acquisition in a row, let alone a third. At the same time, it can be noted that a triple absorption works out more often than a double one, that is, the same reversal signal is preserved here, only it is obtained only when the trader has stopped. There is nothing to be done about this; hardly anyone will want to enter the market after two stops, and in principle this is correct. The only thing that can help is a slight increase in the stop, as indicated above. But there are also risks here; this will inevitably affect the trading statistics of this particular model. So the most reasonable thing is to simply accept the minus on the first entry and not trade further.

How to trade the engulfing pattern - basic Forex strategies

The basis for using the engulfing pattern is the directional movement preceding it. The optimal time frames for working with absorption are H1, H4 and D1.

A prerequisite for opening a transaction is confirmation . This could be the formation of an additional graphic reversal figure, an indicator signal, or a breakout of a trend line. A good reason to enter the exchange is the formation of an outside bar at technical analysis support or resistance levels. On lower timeframes, when trading on Forex, the price may go beyond the level with a false breakout.

enter the market based on a signal in the following ways:

  1. Based on the closing price of the second bar of the model. This is a profitable entry point if the pattern has been identified correctly.

  2. Pending order to buy or sell. This trading system is used for ascending and descending formations. An order to open a position must be placed at a distance of 4-5 points from the Low or High of the second candle - depending on the direction of the reversal. In this case, you need to take into account the size of the spread and add it too. If the strategy signal turns out to be false, the order simply will not be opened.

  3. Opening a trade at the close of the next bar or a pending order in the presence of a confirmation candle. The second strategy is a classic one for entering the market. The previous principle of setting pending orders is used here. Only this time, the Low or High candle that is formed immediately after the pattern is taken into account.

  4. Tactics for entering with a limit order at a 50% retracement. After the second candle of the pattern engulfs the first, the price often retraces 50% of the body of the engulfing bar. Therefore, a limit order to buy or sell is initially placed at this point. There is a risk of missing the entry point in the absence of a correction, but the risk-to-reward ratio increases several times.

When working with absorption, it is not recommended to use a fixed profit order . It is best to choose take profits placed at global and local levels. After a strong price movement in a new direction, you need to move to breakeven as soon as possible.

What happens in the market when a takeover is formed

The formation of this structure occurs as a result of the resolution of a dispute between bulls and bears. The configuration of the candles tells you how confidently one of the parties has gained the upper hand over the opponent. If there are almost no shadows and volatility is high, we get a strong signal about a trend change.


Let's look at how bearish engulfing is formed using this structure as an example. A small gap in the pattern formed over the weekend

The absorption pattern was formed as follows:

  • Day 1 (1st candle on D1) – there was a sharp bearish impulse. In the area of ​​104.65-104.70 they encountered strong support. During the day they tested it 4 times and could not break through;
  • Day 2 (2nd candle on D1) – smooth growth; at the end of the day, on an impulse movement, there was a breakdown of the resistance built on the High of the 1st element of the pattern. This is an additional argument in favor of the truth of the pattern.


This is how a candlestick is engulfed when a bullish pattern is formed.

Subsequently, the chart tested the previously broken resistance from above and an upward movement developed.


A reference to the Forex strategy Sniper. W-shaped design and subsequent retest of the broken resistance. This does not always happen after acquisitions, but such developments reinforce the pattern

You will see a similar scenario when analyzing any pattern of this type. On the 1st candle, the bulls/bears are trying to continue the current trend, but are facing resistance. On lower timeframes you can see how it is tested several times. Then there is a reversal and a breakdown of the resistance represented by the High of the 1st candle.

Absorption is trending

A trading formation can occur within a global price movement. Visually, candles can look perfect - the first is small, the second completely absorbs the first, along with the shadows.

If there is no trading volume on the exchange, then a reversal may not happen. The asset will continue to move in the same direction, and the trader will lose money. For this reason, there is no need to rush to open a trade when an engulfing pattern appears on the chart. Even the visual beginning of a reversal may turn out to be a microtrend or a correction of the main movement.

What is an absorption model?

An engulfing pattern in trading is a combination of two consecutive candles that have a distinctive feature: the price at which the second candle closes completely covers the first candle. That is, we have two differently directed candles. The first of this pair is the last candle in the trend, it can be of different shapes, but usually it is a good trend candle, without long shadows and with a fairly large body.

The one following it, almost from the very moment of opening, begins to go in the direction opposite to the main direction, and does so so confidently that already in the process of formation one may get the impression that the trend has changed. However, the key point will be its closing level. Until this moment, anything can happen.


Absorption pattern on the chart

Once the candle closes, it becomes possible to determine whether we are indeed facing an engulfing pattern. It is distinguished by the closing price, which overlaps the opening price of the previous candle. Hence the name of this combination. In essence, we get a fairly quick overlap of the range - this happens due to the fact that in the same time the price travels a greater distance, and it does so against the trend.

Such a signal indicates that the market situation has quickly changed and now participants are inclined in the other direction. Something similar to a similar situation can be observed in a pin bar or any other reversal pattern, but only when moving to a smaller scale. That is, a pin bar on the M15 chart may contain two five-minute bars in the form of absorption.

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Support and resistance levels

Using levels of technical analysis will allow you to more accurately determine the correct candlestick structures . The price level indicates a limitation on the potential for growth or decline in the value of an asset. If a pattern is formed near the levels, then the probability of a valid signal increases significantly.

As an example, let's take a situation when the price is approaching a resistance area. If the pattern appears, the signal will indicate significant downward potential. This principle also works in the opposite direction.

When viewing the screenshot of EURUSD, we see how the price approached the resistance level and a bearish engulfing formation formed. In the end, the signal turned out to be correct. In a bullish engulfing pattern, price may also approach the support level several times before the pattern is finally formed.

Forex indicators from the MT4 terminal

If you analyze free programs to identify a pattern, then the best option is Vertical Bar Setup . The advantage of the indicator is to search for absorption patterns on the chart and indicate the optimal stop loss and take profit values.

Key Features:

  • Identifies and places stops using ATR.
  • Filters false breakout signals by candlestick extremum.
  • Marks models that did not make a profit.

download Vertical Bar Setup here.

Less popular, but still effective indicators include RFX Pattern Recognition . In addition to absorptions, the program displays a large number of patterns on the chart . You can download it here.

The indicator settings boil down to setting the value true in the Display_Bearish_Engulfing and Display_Bullish_Engulfing g columns. Display the Show_Alert alert on the screen if desired.

Such indicators have a similar principle of operation. The main differences come down to the relationships between the elements of the candles established by the developers. All patterns must be checked manually, since indicators are an auxiliary tool and cannot be completely relied on.

You can use other indicators to conduct additional technical analysis . It is better to add them to the hourly chart.

popular among traders :

  • Stochastic (Stochastic) and RSI . Oscillators indicate that an asset is oversold or overbought. Their confirmation is desirable for trading. Without the market overheating, it is better not to open in the market.
  • Cluster volumes from the futures exchange . Confirms the signal for a trend change. These cluster indicators are not available in the MT4 (MT5) terminal.

After the indicators are installed, you need to wait for the full pattern to form.

If upward absorption is expected, then the second candle shows an increase in volume. At the same time, Stochastic should move up from the oversold zone. If there is a signal with such confirmations, a buy position is opened.

How to automate pattern search

There are several dozen indicators for recognizing candle absorption. There are several free ones in the market, Mark EA CandleStick Pattern, RFX Pattern Recognition (supports all popular Price Action patterns), VerticalBarSetup, Candle Pattern Finder work well. The last indicator is good because in addition to indicating patterns, it is sensitive to the strength of the candlestick structure.

All indicators are similar in operation. The only differences are in what relationships between the elements of the pattern candles were laid down by the algorithm developer.


An example of how Candle Pattern Finder works. Formally, all 3 patterns comply with the rules, but none of them would be worth using


This is how Pattern Recognition performed the markup. He missed the places where the absorption pattern was highlighted by Candle Pattern Finder. This is due to the criteria for evaluating the schedule included in it by the author.


And this is the DI Simple Price Action markup. It uses Price Action terminology

As you can see, the interpretation of the same section of the chart by indicators differs. If you plan to automate work with patterns, test selected indicators on history, and based on the results, decide on your choice.

Please note that in Forex, indicators play the role of an auxiliary tool. Check the results of their work manually. Relate the highlighted patterns to what is happening at that moment in the market.

Setting a stop loss

To properly manage risks when using different types of patterns, consider the rules for setting stop orders:

  • Bearish engulfing . Stop Loss is set slightly above the maximum price level of the second day of pattern formation. It is necessary to fix a loss if this level is broken through by the price maximum within two days and when the market closes above the level.
  • Bullish engulfing . Stop Loss is set a couple of points below the low of the second bar of the engulfing pattern. The loss is recorded when the market closes below this low or if there are two last lows that closed below the low of the second candle.

You cannot use the formation without stops. The price level may break out, which leads to a continuation of the current trend with heavy losses.

Trade

FIGURE 3 Trading according to the pattern
The engulfing pattern needs to be interpreted, because its meaning depends on the conditions in which it occurs. Although the engulfing pattern is a universal pattern, it works best on the D1, H4 and H1 time frames. Major currency pairs with high volatility are recommended for trading.

When trading Price Action patterns, it is recommended in most cases to use pending orders to increase the number of profitable trades, since the price does not always go in the expected direction, this reduces the number of stop losses. This recommendation also applies to the absorption model. The standard way to enter a buy position (see Figure 3) is to place a pending order (Buy Stop) several points above the high of the bullish engulfing pattern. In this case, the stop loss is placed several points below the low of the engulfing candle. The situation is similar for entering sales; a pending Sell Stop order is placed several points below the low of the bearish engulfing pattern, and a Stop Loss is placed several points above the high of the engulfing candle. Take profit can be set at the nearest support/resistance level, or the stop loss can be multiplied by two or three.

Mistakes in trading

The most common mistake is to enter a buy position immediately after an engulfing pattern appears on the chart . An upward formation is often a correction to a downward trend.

Therefore, you need to check signals that strengthen the pattern and receive confirmation of a reversal. If the price moves along the trend and trading volumes are large, it is better not to take risks. To obtain more accurate information, you need to look at lower timeframes . Here you can see whether the formed engulfing pattern is a pullback within the trend.

For example, you can take graph H4.

The chart shows that the daily bullish engulfing pattern was a pullback against the global price movement.

WE Draw CONCLUSIONS

The absorption pattern is an excellent formation that is suitable even for novice traders. Even after basic training on historical data, you can easily get better at it and this pattern will not cause you any special problems in searching.

Article: Trading at the end of the candle

It goes without saying that a lot comes only with experience, and you shouldn’t be surprised if at first nothing really works out for you. This is an absolutely normal topic, you just need to practice and everything will definitely come with time.

The main thing is not to rush, focus on the quality of actions and acquisition of skills. That's all, I hope that this material will be useful to you and you will draw your own constructive conclusions.

Advantages of trading the engulfing pattern

A significant advantage of using the design is to obtain a clear signal of a trend change . But subject to the presence of supporting elements. If a trader sees that the trend has exhausted its potential, volumes are falling and there is reason to expect a reversal, then the absorption pattern allows you to accurately determine the desired point.

Another advantage of the model is that it is simple and easy to find on a chart . Even beginners can use the formation.

Markets on which the takeover is traded

The engulfing pattern can be successfully used in Forex.

With information on volumes, a trader will be able to determine the potential of a trend in Forex and accurately identify the moment of reversal.

A simple engulfing pattern can also be used successfully in the stock market. The markets for binary options, cryptocurrencies, futures and other securities are no exception.

How the pattern looks on the chart

The model consists of 2 candles:

  • the second candle completely engulfs the first. We are talking about the bodies of candles; there is no strict requirement for the absorption of candles. For example, in a bullish engulfing High pattern, the shadow of the 1st candlestick may be above the high of the 2nd element of the pattern. If the requirement for absorption of bodies is met, the model is taken to work;
  • It is desirable that both elements of the pattern be full-bodied, without significant candles. The ideal model is one in which both candles turn into marubozu, that is, they have no shadows at all;
  • the absorption model is formed only at the end of significant movements (both trend and correctional). If you see, for example, a bearish engulfing in the middle of a movement or in a flat, it is simply 2 candles of different colors located nearby.


Close to perfect bearish engulfing

In RA there are models that have the same meaning as absorption:

  • rails are a weaker formation. There is no strict absorption requirement. These are simply large candles of different colors located nearby;
  • outside bar – the 2nd candle absorbs the 1st with a large margin. Its range is at least 3-5 times greater than the range of the first.


The second candle engulfed the first, but the pattern is called an outside bar


There is no bullish engulfing here, this pattern is called rails


There is also no absorption here. Rails weaker signal, pay attention to model development

In Forex, an engulfing pattern rarely forms with a gap, so the Close price for both candles is the same. In the stock market, chart gaps are more common.

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