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The circle is your XP bar.
It also affects, if you have correct jade. For extra dmg on enemy you need to use talisman on them.
One of your potential strategies is to stack internal damage on enemies using Tai-Chi Kick or certain jades and then convert it using talismans.
There was a scarecrow that looked like a training dummy in the first village, I fully thought there might be a Mook Yan Jong (I looked it up), one of those martial arts wooden dummies that swing around at you. I guess that's a little too light-hearted for this game? Only a couple hours in but the tone seems pretty... grave.
I want to add something to this.
Internal Damage on enemies is not always healing.
I believe if you are attacking them in anyway (sticking more talismans, normal sword attacks) or parrying the Internal Damage on an enemy doesnt start to heal yet.
I have tested above by giving the enemy full internal damage without attacking it. Then only parried to see if any of the red bar appeared. Red only started to appear when I didnt attack or parry. (Even if the enemies HP bar left it kept the Internal Damage as long as I kept parrying.)
I believe this may include attacks that are range but I havent tested that scenario yet.
Hopes this helps.