A bearish engulfing pattern is a chart that consists of two candles, with it being a small bullish followed by a bigger bearish candle. It shows the appearance of a reversal, saying that a bull run would end and probably have a further bearish trend.
The secret to this pattern is the interaction between the two candles. The bullish candle closes at a higher price than that at which it opened; the bearish candle, however, which follows, closes at a lower price than that at which it opened. Importantly, the bearish candle’s body completely engulfs the body of the previous bullish candle, indicating that the momentum is going from buying pressure to selling pressure.
This pattern is a signal to the traders that the market may be reversing from an uptrend to a downtrend. Traders often enter short positions using this signal, expecting the price to continue falling.
How to Identify the Bearish Engulfing Candle Pattern
It is an engulfing bearish pattern that is the most commonly traded price action pattern on various timeframes and markets. The following are some characteristics that you need to identify correctly for the correct pattern:
Candle 1: Bullish Candle
It should be a bullish candle, which means it is supposed to close higher than the opening. That way, this candle indicates that the market is still filled with buying pressure.
Candle 2: The second candle should be bearish; that is, it should close lower than it opened.
The key feature is that this bearish candle fully engulfs the body of the first bullish candle. This engulfing action represents a shift in market sentiment from bulls to bears.
So the only way for you to know that the pattern is valid is for both candles to be fulfilled by the above requirements. Once this pattern has been found, traders will generally wait for further confirmation by the price action or some other indicators before acting. Generally, confirmation can be looked at in terms of finding support or resistance levels, use of moving averages, and applying some other technical indicators.
The bearish engulfing pattern is highly intuitive and one of the most effective trades in trending markets. Follow the step-by-step guide as shown below to trade on this pattern:
Wait for Confirmation
First, you need to wait for the bearish engulfing pattern to form. This will normally happen at the end of an uptrend. After the second candle, the bearish engulfing candle, closes, traders should wait for a confirmation candle that would indicate further continuation of the bearish move. This can be another bearish candle that closes lower or a break of a key support level.
Entry
With a confirmation candle in hand, you are able to enter the market by entering short. Ideally, entry happens immediately after the confirmation candle has closed. The issue here is to ensure that the market has indeed made its transition to the downside.
Stop-loss Placement
To reduce risk you will have to place the stop loss above the high of the bearish engulfing candle so that if the market reversed and started going up your position is safe.
Profit Target
You can set your profit target by assessing the risk-to-reward ratio. A common target for a bearish engulfing pattern is a 1:1 risk-to-reward ratio, but traders may adjust this based on market conditions and their trading strategy.
For instance, when it occurs at the peak of an uptrend, and the next candle validates the move downward, it is very easy to enter a short position which may make you collect large profits since the price is likely to drop.
Advantages and Disadvantages of the Bearish Engulfing Pattern
Like all other trading patterns, the bearish engulfing pattern also has pros and cons. This will guide you to take better decisions in your trades.
Advantages
Frequent Occurrence
The bearish engulfing pattern appears in most markets and across various timeframes. Its frequent occurrence makes it easy to spot and trade.
Reversal Signal
It is an ideal pattern for traders looking to trade reversals. The pattern signals that a bearish trend could begin after a strong uptrend, giving traders the opportunity to enter a new market direction early.
High Profit Potential
The bearish engulfing pattern can generate good profit margins when traded at the right time. It can be especially useful when used as an additional confirmation indicator since it allows you to make early entries in profitable trades.
Disadvantages
False Signals in Strong Trends
This is one of the biggest downsides of the bearish engulfing pattern because it sometimes gives false signals when markets have strong trends in bullish movements. It is, therefore, possible for a pattern not to cause a reversal in a still very strong uptrend, hence losing a trader money.
Performance on Flatten Market
The bearish engulfing pattern does not have very high performance in the condition of a flat or even market that consolidates. Even during the sideways move market, it may bring back too much whipsaw situations.
It costs more on larger timeframes. The larger the bearish engulfing pattern, the more your stop-loss needs to be. This can make the pattern expensive to trade, especially on larger timeframes such as the daily, weekly, or monthly charts. In addition, traders face greater financial risks due to the larger stop-loss.
Key Takeaways
- Two candle bodies comprise the bearish engulfing pattern: a smaller bullish one followed by a larger bearish one that engulfs the first.
- It’s a reversal pattern, but most of the time after uptrends, so traders could use it as an opportunity to enter short positions.
- In order for the pattern to perform effectively, more indicators confirming it or further price action analysis will come in handy.
- Risk management is critical since the bearish engulfing pattern is not foolproof, and it may produce false signals in strong trends or flat markets.
For those who are interested in learning more about the bearish engulfing candle, be sure to visit the HowToTrade.com Trading Academy. There, you will find detailed tutorials and real-market examples to help you incorporate this pattern into your trading strategy.
