In order for an Engulfing setup to be valid, both candles must have short wicks. Precisely, we require the total length of the wicks to be no more than 33% of the entire candle’s length. In other words, the majority of the candle must be body. Long wicks represent indecision rather than sustained direction. (Some traders prefer to use a stricter definition of wicks being no longer than 25% or even 20% of the entire candle length.)
Secondly, we give some allowance on how much the first candle’s body is covered. We accept a setup if at least 90% of the first candle’s body is covered by the second candle’s body.
Let’s look at an example of this in action on the AUD/USD daily chart:
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The entry would be the open of the next candle and the stop-loss above the high of the second candle in the setup. As a minimum, aim for a 1:1 risk/reward ratio. In this case, the potential first profit target was hit quickly and cleanly.
The conditions for an Engulfing setup are quite strict, and valid setups take time to appear. The temptation is to move down to lower time frames to find them. However, in our experience their accuracy is particularly potent on hourly charts and above.
In fact, we regularly trade them on four-hour and daily charts for our longer-term signals. The advantage with higher time frames is that spreads matter less because of higher profit targets—this allows you to monitor more pairs that you may not usually consider.
An Engulfing setup is a two-candle setup whereby each candle has short wicks and the second candle’s body covers the range of the first candle’s body.
The setup is easy to spot visually, and can be traded in isolation or tied in with surrounding price action. Higher time frames, such as the daily chart, produce more accuracy.