Understanding The Engulf
As mentioned in the previous lesson on supply and demand basics, we expect price to turn at supply and demand levels. When it does we can say that the level held. When the SD levels do not hold however, this can still give an indication of where price likely to go.
Let’s say we have what we believe to be a quality supply level marked up on our charts. We anticipate that when price reaches that level, it will fall. If however price rallies through the level, it has been engulfed/broken. This is very important as it tells us that the market is likely to continue to rally higher if other conditions are met of course which we will come to later. When this happens the market is telling us we should be looking for longs now. We know that price rallies when demand is greater than supply and the engulf of supply tells us that there may be demand level sat somewhere below which caused the engulf. If there is one then this is where we want to trade long from.
The supply level itself does not have to be a significant one. By that I mean it does not necessarily have to meet the standard criteria for a short. The engulf is the most important thing. Please see the example below:
It’s a similar situation with demand levels. If a demand level is engulfed then the sellers caused this and it’s likely that price will continue to fall now the demand level has been broken. Finding a supply level to short from would be the best way to get in on the action here provided that there is enough profit potential on for the trade.
You’ll notice that every single trade I post features at least one engulf but usually more. This is because it’s such a great tool for understanding where price is likely to go and when combined with supply and demand it can be very powerful. The demand level engulfed does not have to be a tradable one. Once again the engulf is the main thing to consider. Please see the example below:
Engulfs of other significant areas can also help identify market direction. A DP or decision point is simply an area on a price chart where a decision was made. This could be to move price higher, lower or to prevent price from doing either of the above. This is not supply and demand but some of these areas might fall into the category of what is commonly known as support and resistance.
When these areas are engulfed this also provides clues of where price is likely to go and how far.
Please see the example below: