Whether you trade pullbacks or look for complete trend reversals, the bearish engulfing pattern is a two candlestick chart pattern that helps you find a trade entry or as a source of information as to the strength of the bulls in the market you are trading.
Highlighting sentiment shifts in the market from bullish to bearish, the bearish engulfing candlestick pattern is an easy to spot price reversal pattern which makes them ideal candidates for price action traders.
They can also be used as a trade trigger for traders who use a mechanical approach to trading as in the case of using trading indicators for trading decisions.
Bearish Engulfing Pattern Explained
In a bullish market we are looking for the bearish engulfing to appear and overlap the preceding bullish candlesticks real body. This means;
- The open of the bearish engulfing candlesticks is higher than the close of the previous candlestick – can be equal
- The close of the bearish engulfing candlestick is lower than the open of the previous candlestick – can be equal
As you can see, we need two candlesticks to form this price pattern.
There are a few conditions that must be met before considering the appearance of a bearish engulfing pattern.
Are we in a defined trend to the upside?
We want to ensure the market is actually trending and not stuck in a trading range. An up-trending market will have traders on one side of the market and the effectiveness of any candlestick reversal pattern depends on how many traders are caught on one side of the market.
How far does the engulfing candle travel?
The appearance of the engulfing candle, depending on the severity of the candlestick, can be enough to tilt the bulls and have them exit their trading positions. In terms of severity, we would love to see the bottom of the candlestick fall a great distance beyond the previous low.
The further the engulfing candle travels past the low, the better the odds of bulls being discouraged from long positions and a trend reversal taking place.
Are we at a technical zone?
Having engulfing reversal patterns show up anywhere on the chart is not productive for traders. We want to see the bearish engulfing pattern show up at technical zones such as prior resistance or measured move objectives from higher time frame trends and consolidations.
Some traders may use moving averages but ensure that there is some price structure to the left of the average.
Examples Of Bearish Engulfing Candlestick Patterns
Notice about this Forex chart that the engulfing pattern coincided with a resistance area (not shown) that dated back to 2008. This is a weekly chart and the bearish engulfing pattern showed up after:
- An extended up trend
- At a technical price zone
- After a momentum run to the upside in price
- The body of the reversal candlestick engulfs and exceeds the low of the previous candle
All those combined, even if you did not trade the actual trend reversal, would give you valuable information going forward.
Trading Pullbacks With Engulfing Patterns
While bearish reversals are used for markets in an overall up trend and you look for the reversal, keep in mind that trends are relative to time.
In a down trending market, it is not uncommon to see the price action trend pattern of higher highs and lows as markets going through complex corrections giving you a short term up trend.
An even better example is a higher time frame retrace in price in an overall down trending market and using the lower time frame up trend completion as a trade entry.
Bitcoin has been a bit of a free-fall and this chart is going to highlight some technical aspects that were important and the appearance of the bearish engulfing pattern gave a trade entry.
- This line represents a higher swing low level from the higher time frame. Once that level is broken on the daily chart, the tide starts to turn for the trend
- Price puts in a lower low on the higher time frame here and even though the green candle looks like a trade – we are trading in relation to the higher time frame trend change
- Price rallied up to the bottom side of former support on the lower time frame. The market is putting in higher highs and lows on this time frame which is a price action pattern up trend
Remember – we are trading the higher time frame potential down trend (there were other factors such as downwards momentum). We are using the smaller time frame uptrend to position into the higher time frame trend – multiple time frame trading.
At #3, price is basing under potential resistance and odds favor a breakout with that pattern. Higher prices get rejected and then we get a small range candlestick which gets eaten up by the bearish engulfing.
That is a short trade.
Stops And Targets For Bearish Engulfing Candles
There are three things to consider:
- Are you trading with the plan for a complete trend change?
- Are you trading a smaller time frame retrace against the higher time frame trend?
- Are you using this price pattern for information only?
If a trader is using the bearish engulfing candle at a technical level as a change in trend, where would this trader be wrong? When price exceeds the high of the engulfing candlestick.
Due to what the engulfing pattern signifies and should demoralize bulls, the failure of the highs of this candlestick would show at that point, it does not carry the weight we expect. You’d want to keep a fairly close stop and monitor for any momentum move against the reversal candle.
Trading the lower time frame trend against the higher time frame trend, you may want to keep a slightly wider stop. While the lower time frame may be undergoing a complex correction, that may only be a simple correction on the higher time frame.
It is possible that a tight stop on the lower time frame may be taken out if the complex correction is underway on the higher time frame.
Using these patterns as information going forward is a smart play if using a different type of trading strategy. If you look back at the last chart, you can see consolidations breaking to the downside. You can use the trend reversal as a sign to only look for support breaks from consolidation as long as the price pattern of lower highs and lows stays intact.
Price targets would apply depending on your strategy. Obviously if you are looking at a complete trend change as your plan, you may want to include a trailing stop method of trade management. It is possible that you are catching the beginnings of a large move.
If using the bearish engulfing pattern as an entry from a pullback in price, you can use anything from risk to reward targets to measured moves and trailing stop.
Using Bearish Engulfing Candlestick Patterns
As part of an overall trading strategy, the bearish engulfing reversal is a great tool in terms of seeing momentum coming into the market.
If the reversal is strong enough, the bulls that are running towards the exits and new bears stepping in, you can be up a significant amount of pips in a short time.
Using this price pattern at technical levels such as support and resistance levels is better than trading them blindly.
Ensuring a strong trend came before the reversal can tilt the odds in your favor that you’ve caught either a major correction or an entire trend change.