You have all seen me use my three favorite candlesticks: the doji, the hammer and the hanging man.
They are great at signaling changes in stock trends.
Now I would like to introduce a new candlestick formation to our repertoire.
It is called an engulfing pattern and it also signals trend changes.
The engulfing pattern requires two consecutive candlesticks — which can be bullish or bearish — and is found at the top of an uptrend or the bottom of a downtrend.
The engulfing pattern looks just like the name. It is a candlestick that engulfs the whole real body of the previous candle.
Behold the bullish version …
- A bullish engulfing pattern will be a green candle (or white), taking over the real body of the previous candle which has to be red (or black).
- It does not have to engulf the upper or lower shadows, if there are any.
- It is found at the bottom of a downtrend which can be short term in duration.
And the bearish version …
- A bearish engulfing pattern will be a red (or black) candle following and engulfing a green (or white) candle.
- It will engulf the whole real body but doesn’t need to include the upper or lower shadows.
- It will be found at the top of an uptrend.
Here is the bullish engulfing pattern in Plug Power (Ticker: PLUG).
It has since traded higher and I think it will continue to trade up to at least $30.50.
PLUG traded a high of $75.49 on Jan. 26 and has been in a downtrend ever since.
The recent low was $18.47 on May 11. It closed at $24.58 on Friday.
Looking at the options, I would like to buy a call spread in the Jun18 cycle. It has good volume trading and the markets are pretty narrow.
I like buying the Jun18 25 calls with an implied volatility of 92.08 and selling the 31 calls with an implied volatility of 95.28.
Paying $1.60 for this six point spread with 35 days until expiration is a great value.
Now there are two caveats to this trade idea …
- The earnings come out on May 20, which will most likely move this stock and the volatility can come down once the earnings are announced.
- Since I am only paying $1.60 for this spread and it has 35 days until expiration I am willing to ride out the earnings announcement.
If the spread trades below a dollar, I will take my losses. I would like to see the stock trade close to $30 before I begin to take any profits.
I hope I have helped you expand your mind — and your trading account!
Thanks for Reading … See You Next Tuesday!