Bullish and Bearish Engulfing Patterns

The engulfing candlestick is one of the most common patterns used by traders to identify trend reversals and continuations after a pullback in the financial markets. The engulfing pattern can be found in all financial markets, including forex, stocks, indices, and cryptocurrencies.

In this article, we’ll explore the engulfing candlestick pattern and how it can be used to improve the accuracy of your trade entries. We’ll also discuss some trading strategy ideas that can help you improve your trading edge and make more informed trading decisions.

Before we dive into the topic, I want to emphasize that trading engulfing candlestick patterns alone, without practice and experience, won’t make you rich overnight. While candlestick patterns can be profitable, it requires a certain level of experience to use them effectively. If you’re a beginner, it’s crucial to keep this in mind and approach patterns trading with a realistic mindset. By gaining knowledge and practicing, you can develop a better understanding of the markets and how to use patterns to your advantage.

Bullish Engulfing Pattern

A bullish engulfing pattern is a candlestick pattern that signals a potential reversal of a downtrend or a continuation after a retracement (or pullback). This pattern consists of two candles: the first candle is a relatively small bearish candle, followed by a larger bullish candle that completely engulfs the previous candle. The bullish candle typically opens lower than the previous candle’s close and closes higher than the previous candle’s high. In many cases, the open of the second candle is the same as the close of the previous candle and this can be considered a valid pattern as well.

In general, you will find that engulfing patterns are more accurate on higher timeframes such as daily or weekly and are the most ideal for predicting short-term movements.

What Does a Bullish Engulfing Pattern Look Like?

For a bullish engulfing pattern to be valid, the following conditions must be met:

• For reversal signals, the preceding trend should be a downtrend with higher lows and lower lows.
• For trend continuation signals, the preceding trend can be an uptrend or downtrend.
• The first candlestick of the pattern must be bearish (red) and have relatively small shadows.
• The second candlestick should completely engulf the first candlestick and be bullish (green).

Below is an example of a perfect bullish engulfing pattern formed on 11 December, 2020 indicating a trend continuation after a pullback for the APPL stock.

Bearish Engulfing Pattern

The bearish engulfing pattern is the opposite of a bullish engulfing pattern. It signals a potential reversal of an uptrend or a trend continuation after a pullback.

It consists of two candles: the first candlestick is bullish (green) and the second one is a larger bearish (red) candlestick that completely engulfs the previous one.

The bearish candle opens higher than the previous candle’s close and closes lower than the previous candle’s low. But like its bullish counterpart, the bearish engulfing pattern can also have the open of the second candle equal to the close of the previous candle and still be considered a valid pattern.

What Does a Bullish Engulfing Pattern Look Like?

For a bearish engulfing pattern to be valid, the following conditions must be met:

• For reversal signals, the preceding trend should be an uptrend with higher highs and higher lows.
• For trend continuation signals, the preceding trend can also be a downtrend.
• The first candlestick of the pattern must be bullish (green) and have relatively small shadows.
• The second candlestick should completely engulf the first candlestick and be bearish (red).

Below is a great example of a bearish engulfing pattern formed on 29 March, 2022 indicating a trend reversal for the NFLX stock.

Engulfing Pattern Strategy Ideas

As a trader, it’s important to understand how to act on engulfing signals and determine whether a pattern represents a shift in market sentiment or it’s a false signal.

One approach that aggressive traders usually take is to buy immediately after an engulfing candle formed based on the rules described in the previous sections. However, this strategy requires a higher tolerance for risk because not all engulfing patterns will be successful.

Below is an example of a valid bearish engulfing pattern that occurred on 13 September 2022 in an uptrend on TSLA stock. Based on textbook rules, such a pattern should indicate a trend reversal. However, in this particular case, the pattern proved to be false, and the stock’s upward trend continued.

It’s important to know that not all patterns play out and adding more confirmation signals in your trading strategy can significantly increase your success rate. When analyzing the markets with the candlestick patterns, consider both the pattern itself and the broader market conditions. Here are some key steps to take:

Study the Market Cycles: Once the pattern has been identified, you should analyze the overall market conditions to determine if they are favorable for the candlestick pattern that you want to trade with. This analysis should include a review of the trend and volatility of the market, as well as any fundamental factors that may be impacting the market. Learn more about market cycles in our detailed guide: Crypto Market Cycles: Staying Ahead of the Game

Look for Confirmation: While candlestick patterns can be strong signals for trend reversal or continuation, traders should always look for confirmation of the pattern before taking a position.

Confirmation can come in the form of a follow-through day, which is a day where the market closes higher than the previous day’s high. Traders can also look for additional patterns or use momentum oscillators like stochastic or RSI to confirm the signal.

Risk Management: Finally, you should take into account your risk management plan. This includes setting a stop loss order at an appropriate level to limit potential losses and a take profit level to maximize profits.

Now, let’s explore some strategy examples that demonstrate how combining engulfing patterns with other signals can improve your chances of success.

Strategy 1: Bearish Engulfing and Fibonacci Retracement

It is common for beginner traders to overcomplicate trading. If you’re just starting out, please don’t go down that rabbit hole. Trading doesn’t have to be complicated and still can be profitable. Here is a simple strategy that can give you the edge you need in the markets.

Bearish Engulfing and Fibonnaci Retracement Trading Strategy

We now know what a Bearish Engulfing pattern is and what information it provides when it forms in a downtrend, but what about Fibonacci Retracements.

(Recap) Bearish Engulfing Pattern: This is a candlestick pattern that occurs when a small green candle is followed by a larger red candle that completely engulfs the previous candle. This pattern is seen as a bearish reversal signal.

Fibonacci Retracements: Fibonacci retracements are a popular technical analysis tool used by traders to identify potential levels of support and resistance. These retracements are based on the Fibonacci sequence, which is a series of numbers where each number is the sum of the previous two. The most commonly used Fibonacci retracement levels are 38.2%, 50%, and 61.8%.

Now, let’s look at how these two concepts can be combined in a trading strategy.

Trading rules

1. Predominant trend must be a downward trend
2. Bearish engulfing pattern
3. Fibonacci resistance level 38.2%, 50% or 61.8%
4. Go short

The first step is to identify a trend, like the one in the picture below: NFLX stock from 13 February, 2023 to 23 March, 2023. The trend is downwards with higher lows (green ✓) and lower lows (red ✓). In this case we are looking for a bearish engulfing pattern to form after a retracement.

In a downtrend, a bearish engulfing pattern is only valid for indicating a trend continuation, not a trend reversal. For a trend reversal signal, the trend needs to be an upward trend.

Next, we will use Fibonacci retracements to identify potential levels of support and resistance. These levels can be used to determine entry and exit points for our trades.

In the graph below we can see our first valid signal for an entry. A fibonacci retracement level of 38.2% acting as resistance, and a bearish engulfing pattern in the same area.

After the bearish engulfing pattern is formed, we can look to enter a short position. More aggressive traders would enter right after the patterns and fibonacci level is confirmed. More conservative traders would wait for more confirmation.

For example, I am always analyzing the trade setup on multiple timeframes and looking for confluence signals to find the best entry price.

Considering the example above, if we switch the timeframe from 1H to 15M, we will see a bearish pattern formed at the same time like the one formed in the hourly chart. At this point, I would consider shorting NFLX.

Strategy 2: Bullish Engulfing, Trendlines and Relative Strength Index (RSI)

Bullish Engulfing, Trendlines and Relative Strength Index (RSI) is a powerful trading strategy that combines three key technical analysis tools to identify potential reversal points in the market.

The first component of this strategy is the bullish engulfing pattern, which is a candlestick formation that indicates a potential reversal from a downtrend to an uptrend. A bullish engulfing pattern is identified when a candle with a small (red) body is followed by a much larger bullish (green) candle that fully engulfs the preceding candle.

The second component is the use of trendlines to confirm the reversal. A trendline is a straight line that connects two or more price points and represents either support or resistance for the asset’s price. The trendline must be broken to validate the signal.

The third component is the Relative Strength Index (RSI) indicator. The RSI is a momentum indicator that compares the magnitude of recent gains to recent losses, and it ranges from 0 to 100. When RSI is close to 30, it indicates an oversold situation where bears could start losing power in the market and bulls can take over the control anytime.

Now, let’s look at how these three components can be combined in a powerful trading strategy.

Trading rules

1. Predominant trend must be a downward trend
2. Bullish engulfing pattern
3. RSI oversold ~30
4. Trendline breakout
5. Go long

Below you can see a great example of this strategy in action. All trading rules were met on the EUR/USD chart on 28 September, 2022. For entry, a close above the trendline could be a good option. For stop loss, refer to this detailed article about best stop loss strategies for trading.

Mistakes to Avoid When Trading Engulfing Patterns

• Entering a trade too early, before the pattern is fully confirmed.
• Failing to set stop-loss orders to minimize potential losses.
• Overtrading, which can increase risk and lower profitability.
• Ignoring broader market conditions like trend and volatility.
• Lacking a clear exit strategy, which can lead to missed opportunities or unnecessary losses.

Best Platform to Trade Candlestick Patterns

When trading candlestick patterns, having the right platform is crucial to success. Here are some key factors to consider when choosing the best platform:

• Maximum Flexibility: Look for a platform that allows you to go long or short on any asset and use leverage to profit from even the smallest signals in any direction.
  
• Variety of Assets: A good platform should offer a diverse range of assets to trade from, including stocks, cryptocurrencies, commodities, forex, and unique markets. This ensures you can always find useful patterns and profitable markets to trade.
  
• Great Indicators and Advanced Chart View: The platform should have great indicators and an advanced chart view that allows you to save templates you have created and combine multiple indicators to get the best edge possible.
  
• Infinite Liquidity: Choosing a platform with infinite liquidity is important, so you can close every position at the exact price you aimed for and have no slippage.
  
• Zero Fees: Look for a platform that offers zero fees, so even if you want to scalp some quick profits, you do not lose on the fees. Combined with fractional trading, you can get in on every position for less than $1.

If you’re looking for a platform that offers all of these features, Morpher is a great choice. It’s specifically designed to provide the best trading experience possible, with maximum flexibility, a wide range of assets to trade, great indicators and an advanced chart view, infinite liquidity, and zero fees.

Conclusion

Engulfing patterns are some of the most powerful and reliable indicators in technical analysis, especially when combined with other indicators. These patterns are easy to identify and interpret, making them an essential tool for traders.

Disclaimer: All investments involve risk, and the past performance of a security, industry, sector, market, financial product, trading strategy, or individual’s trading does not guarantee future results or returns. Investors are fully responsible for any investment decisions they make. Such decisions should be based solely on an evaluation of their financial circumstances, investment objectives, risk tolerance, and liquidity needs. This post does not constitute investment advice.