A bullish engulfing pattern is a candlestick formation where a small black candlestick is followed by a larger white candlestick on the next day, with the white candlestick's body fully covering or "engulfing" the body of the previous black candlestick. This pattern is considered more likely to indicate a reversal if it appears after a series of four or more consecutive black candlesticks. When analysing a bullish engulfing pattern, investors are advised to consider not just the two candlesticks that form the pattern but also the sequence of candlesticks leading up to it.
Find out how you can identify the bullish engulfing candlestick pattern, what it indicates, how to trade in a market that has this pattern and what its limitations are.
What is the bullish engulfing pattern?
The bullish engulfing candlestick pattern is a two-candle signal that occurs over two trading days or sessions. It typically occurs at the end of a downtrend and, when accompanied by the appropriate confirmation signals, could indicate a potential bullish reversal in the market.
Here is what the two candlesticks in this pattern look like:
- The first candle: The first candle in a bullish engulfing pattern is a red (or black) candle that represents a bearish trading session. Here, the closing price of the stock or security is lower than its opening price.
- The second candle: The second candle in the bullish engulfing pattern is a green (or white) candle. It represents a bullish session where the price of the stock or security closed well above its opening price. This bullish candle completely engulfs the first bearish candle, leading to the name of the pattern.
How to identify a bullish engulfing candlestick pattern?
A Bullish Engulfing Pattern is a technical analysis indicator that suggests a potential reversal of a downtrend. It is characterized by two consecutive candlesticks:
- A small bearish candle: This represents a period of selling pressure.
- A larger bullish candle: This candle must completely engulf the bearish candle, indicating a stronger buying force that has overcome the previous selling pressure.
Steps to identify a bullish engulfing pattern
- Identify a downtrend: Look for a series of lower highs and lower lows in the price chart.
- Locate a small bearish candle: This candle should be at the bottom of the downtrend.
- Look for a larger bullish candle: This candle should follow the bearish candle.
- Verify engulfment: The bullish candle's body must completely enclose the bearish candle's body.
- Check price range: The bullish candle's high should be higher than the bearish candle's high, and its low should be lower than the bearish candle's low.
- Consider context: The pattern is more significant if it occurs after a significant price decline.
- Confirm with other indicators: Use additional technical analysis tools, such as volume and momentum, to strengthen the signal.
Decoding the bullish engulfing pattern
In the bullish engulfing candlestick indicator, the second candle covers the first entirely. Since the second candle represents a bullish session, here is what the pattern tells you about the price movement on day 2.
- The price opened lower on day 2 than the closing price on day 1.
- Then, by the end of the second day, the price shot up and closed well above the opening price on day 1.
This is why the real body of the second candle engulfs the body of the first one. It indicates that the sellers dominated the market on the first day, leading to a bearish candle. Then, when the markets opened on the second day, the sellers continued to push the market down, leading to a lower opening than the previous day’s close.
However, the buyers or the bulls gain control over the second trading session and drive the price steeply upward, so it closes much higher than the previous day’s opening. This price action indicates a switch in control from the sellers to the buyers. Hence, the bullish engulfing pattern is considered a possible indicator of a bullish reversal.
Importance of the bullish engulfing candlestick pattern
A bullish engulfing pattern is characterised by the following conditions:
- Price movement: A downward price movement is followed by a significant upward price movement.
- Open price: The current trading session's open price must be lower than the previous session's close.
- Close price: Regardless of intraday price fluctuations, the current session's close price must be higher than the previous session's close.
This pattern often appears at the bottom of a downtrend in a trending market.
Interpretation: A bullish engulfing pattern signals a potential short-term reversal in market sentiment, often triggered by news events, announcements, price corrections, or other positive factors.
Confirmation: To enhance the reliability of the reversal signal, consider the following:
- Preceding candles: If the bullish engulfing pattern is preceded by a series of consecutive downward candles, it strengthens the reversal indication.
- Subsequent candles: A subsequent upward candle that closes above the high of the bullish engulfing pattern further confirms the reversal.
Significance: The bullish engulfing pattern marks a point where buyers have gained control over the market, potentially indicating a shift in momentum.
How do you trade a bullish engulfing pattern
Noticing a bullish engulfing candlestick on a chart is not enough to chart out a buying strategy. You need to confirm the potential reversal with other signals that typically accompany a switch to an uptrend. Here are the confirmation signals to look for when you want to trade a bullish engulfing candle.
- The candles before day 1: To confirm a reversal when a bullish engulfing candlestick appears, you need to check the candles that come before the first trading session in the pattern. Ideally, there must be at least four red/bearish candles before the pattern to establish a prevailing downtrend.
- The candle after day 2: Once the green candle appears in the bullish engulfing pattern, look for confirmation in the next session. A bullish candle could indicate that the buyers have taken control of the market and set the stage for a confirmed reversal from a downtrend to an uptrend.
- The trading volume: The trading volume may be moderate on day 1, but in the bullish trading session on day 2, you should ideally notice rising volume as the price goes up. This indicates growing interest among buyers along with fading interest among sellers — which is just the confirmation you need for a bullish reversal.
Limitations of using engulfing patterns
A bullish engulfing candlestick pattern has a few limitations that you should be mindful of before you enter a trade. Firstly, if the pattern occurs after a vague or choppy downtrend, it may not be a powerful indicator of a reversal. Also, if the second candle in the pattern is significantly large, it indicates a huge price jump on day 2. This means you may have to set a huge stop-loss if you enter the market at this point — leading to a skewed risk-reward ratio.
Conclusion
The presence of a bullish engulfing candle could indicate a potential reversal from a downtrend to an uptrend. If you notice this pattern in the broad market or in a stock you are tracking, make sure you check for other confirmation signals like increased trading volume in the second session, subsequent bullish candles, and a breakout from a previous resistance level. This way, you can make a more informed decision.
