What is a Bearish Engulfing Pattern?
A bearish engulfing pattern is a technical chart pattern that signals lower prices to come. The pattern consists of an up (white or green) candlestick followed by a large down (black or red) candlestick that eclipses or “engulfs” the smaller up candle. The pattern can be important because it shows sellers have overtaken the buyers and are pushing the price more aggressively down (down candle) than the buyers were able to push it up (up candle).
What Does the Bearish Engulfing Pattern Tell You?
A bearish engulfing pattern is seen at the end of some upward price moves. A larger second candle that indicates a shift toward lower prices overtakes or engulfs the first candle of upward momentum to mark it. The pattern has excellent reliability when the open price of the engulfing candle is well above the close of the first candle and when the close of the engulfing candle is well below the open of the first candle. A much larger down candle shows more strength than if the down candle is only slightly larger than the up candle.
The pattern is also more reliable when it follows a clean move higher. If the price action is choppy or ranging, many engulfing patterns will occur, but they are unlikely to result in significant price moves since the overall price trend is choppy or ranging.
Before acting on the pattern, traders typically wait for the second candle to close and then take action on the following candle. Actions include selling a long position once a bearish engulfing pattern occurs or potentially entering a short position. If entering a new short position, a stop loss can be placed above the high of the two-bar pattern.
Example of How to Use a Bearish Engulfing Pattern
The chart example shows three bearish-engulfing patterns in the forex market. The first bearish engulfing pattern occurs during a pullback to the upside within a more significant downtrend. The price proceeds lower following the pattern.
The following two engulfing patterns are less significant considering the overall picture. The price range of the forex pair is starting to narrow, indicating choppy trading, and there is a tiny upward price movement before the patterns form. A reversal pattern has little use if there is little to reverse. Within ranges and choppy markets, engulfing patterns frequently occur but are not usually good trading signals.
The Difference Between a Bearish Engulfing Pattern and a Bullish Engulfing Pattern
These two patterns are opposites. A bullish engulfing pattern occurs after a price moves lower and indicates higher prices to come. The first candle, in the two-candle pattern, is down. The second candle is a larger up candle with a natural body that fully engulfs the smaller down candle.
Limitations of Using a Bearish Engulfing Pattern
Engulfing patterns are most useful following a clean upward price move, as the pattern clearly shows the shift in momentum to the downside. If the price action is choppy, even if the price rises overall, the engulfing pattern’s significance is diminished since it is a reasonably common signal.
The engulfing or second candle may also be huge. This can leave a trader with a huge stop-loss if they opt to trade the pattern. The potential reward from the trade may not justify the risk.
Establishing the potential reward can also be complicated with engulfing patterns, as candlesticks don’t provide a price target. Instead, traders will need to use other methods, such as indicators or trend analysis, to select a price target or determine when to get out of a profitable trade.
Conclusion
- A bearish engulfing pattern can occur anywhere, but it is more significant if it occurs after a price advance. This could be an uptrend or a pullback to the upside with a more significant downtrend.
- Ideally, both candles are of substantial size relative to the price bars around them. Two tiny bars may create an engulfing pattern, but it is far less significant than if both candles are large.
- What matters is the candlesticks’ natural body—the difference between the open and closed price. The natural body of the down candle must engulf the up candle.
- The pattern has far less significance in choppy markets.
