Importance of Bearish Engulfing Pattern
Engulfing candles are significant indicators of potential market reversals. These patterns, particularly bullish and bearish engulfing, signal a shift in price direction. When a new candle completely envelops the previous one, it suggests a change in momentum. This reversal is often due to a weakening of the prevailing trend and the emergence of a counteracting force. Both patterns typically occur at the end of a trend. A bullish engulfing pattern, for instance, indicates a potential uptrend, as the second candle's low is lower than the first's, demonstrating a stronger buying pressure.
How to identify a Bearish Engulfing Pattern
Merely noticing a bearish candle engulfing a bullish candle is not enough to assume that it is a bearish engulfing candle, signalling a trend reversal. To identify a strong bearish engulfing indicator, you need to look for other accompanying confirmation signals like the following:
- Prevailing trend: Before a potential bearish engulfing appears, the prices must have been moving upward, signalling a prevailing uptrend.
- Trading volume: The trading volume on day 1 of the bearish engulfing formation may be moderate to high, especially among the sellers in the market. However, on day 2, the higher the selling volume, the stronger the reversal indicated by the Bearish Engulfing Pattern may be.
- Support level breakouts: You can also confirm a reversal by checking if the price breaks out below the prevailing support line. This means that the selling pressure dominates over the buying pressure.
- Next-day confirmation: If you are a conservative trader, you can wait for a day to confirm the reversal. If the candle following the Bearish Engulfing Pattern is bearish, it means that sellers have continued to dominate the market, indicating a persistent downtrend.
How to use a bearish engulfing pattern
The bearish engulfing pattern is a potential sell signal, often prompting traders to take short positions. However, real-world trading strategies can vary.
Consider a daily candlestick chart, where each candle represents a day's price movement. If the volume increases significantly during the formation of the engulfing candle, it could indicate a stronger downward trend. In such cases, aggressive traders might sell their positions at the end of the day when the engulfing candle forms.
Example of how to trade a Bearish Engulfing?
The Engulfing Bearish pattern is a technical indicator suggesting a potential reversal from an uptrend. It consists of two consecutive candlesticks. The first candle is relatively small, while the second candle completely encompasses the first and closes in the opposite direction. Unlike the Outside Reversal pattern, it is not necessary for the second candle to completely engulf the entire range of the first candle; merely the open and close are sufficient. The provided chart illustrates two instances of the Engulfing Bearish pattern, both of which successfully predicted a reversal in the trend.
Trading a Bearish Engulfing Pattern
If you notice and confirm a Bearish Engulfing Pattern, you may want to capitalise on the potential downtrend it indicates. This is an ideal time to initiate a short position in the stock or security.
The stop-loss for your trade must be the highest price in the session, as represented by the engulfing candle. This way, even if the price rises upward when you have entered a short position, you can limit your losses.
Additional read: Fear and greed index
How to trade with Bearish Engulfing Patterns
- Professionally, this bearish engulfing pattern signals a potential market downturn. Traders often initiate short positions upon its formation, though diverse strategies exist.
- On a daily candlestick chart, each candle represents a day's price fluctuation. A significant volume increase during engulfing candle formation suggests a robust downward trend. Aggressive traders may sell at the day's close.
- Beyond the pattern itself, traders often observe additional indicators, such as the price breaching the upward support line. This enhances the pattern's credibility.
- To confirm the trend, some traders strategically wait for a day post-formation, especially during periods of market weakness. This cautious approach reinforces prudent trading decisions.
The limitations of a Bearish Engulfing Pattern
The Bearish Engulfing Pattern is generally quite reliable, especially if it is accompanied by adequate confirmation signals. However, it does have a few limitations that you must be mindful of.
- The reversal may not be strong enough if the bearish engulfing candle is not backed by strong trading volume.
- A Bearish Engulfing Pattern also does not guarantee a reversal.
- The effectiveness of the pattern also depends on the timeframe and other macroeconomic factors.
Sometimes, despite strong confirmation, the reversal following a Bearish Engulfing Pattern may not be persistent enough. In that case, you can exit your trade and reevaluate the market trend before entering a new position.
Conclusion
The appearance of a Bearish Engulfing Candlestick Pattern in the market is a sign that you may need to develop a strategy for a potential downward market. If you are a trader, this may be a suitable time to enter short positions. However, if you have already purchased the stock or security, a bearish engulfing candle may cause you to panic. Remember to avoid impulsive decisions and watch the markets to better plan your strategy — whether it is to hold or to sell.
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