The Engulfing pattern is called tsutsumi in Japanese and is a major trend reversal pattern. It is similar to the Outside Day reversal pattern and is the inverse of the Harami pattern with the exception that the candlesticks that make up the pattern cannot be of the same color.
Like the Harami pattern, the Engulfing pattern is a double candlestick pattern that consists of two candlesticks with the first candlestick being a relatively short candlestick with a short real body that is supportive of the current trend. The second candlestick is a larger candlestick that gaps away from the first candlestick's close in the direction of the trend. This candlestick then reverses direction with a larger real body that completely engulfs the real body of the first candlestick. Hence, the two candlesticks that form up this pattern do not have the same color. The Engulfing pattern is a trend reversal pattern and must therefore appear in an existing trend. The pattern is more reliable if it appears at or near a support or resistance line, or a trend line. This is further enhanced when the volumes on the second candlestick are higher than the volumes on the first candlestick. The colors of the candlesticks are also important.
The Engulfing pattern can be either bearish or bullish, depending on where it appears on the price chart.
The bullish Engulfing pattern appears must appear in a downtrend. The first candlestick in this formation must be supportive of the downtrend and must thus be a black or dark colored candlestick that closes lower than where it opened. This suggests that the trend is continuing, as does the open of the second candlestick, which gaps down and opens lower than the close of the first candlestick. However, the second candlestick changes direction and exceeds the length of the real body made of the first candlestick, closing higher than the open of the first candlestick. As the second candlestick's close is higher than its open, it is a white candlestick; and as its open is lower than the close of the first candlestick and its close is higher than the open of the first candlestick, its real body is larger than the first candlestick and completely engulfs the first candlestick's real body. The smaller real body of the first candlestick indicates a degree of indecision and uncertainty in the downtrend and the larger body of the second candlestick indicates that demand has exceeded supply and that the onset of an uptrend is very possible.
The bearish Engulfing patterns should appear in an uptrend and marks the possible reversal of the uptrend. The first candlestick in this formation must be in the direction of the uptrend and must thus be a white candlestick with a closing price that is higher than its opening price. This implies that the uptrend is still strong. The second candlestick gaps up to open above the close of the first candlestick but then reverses to close below the open of the first candlestick, Engulfing it completely. As is the case in the bullish Engulfing pattern, the smaller real body of the first candlestick indicates a degree of indecision and uncertainty about the uptrend. Then larger body of the second candlestick indicates that supply has exceeded demand and that the onset of a downtrend is very possible.