Bearish Engulfing Candlestick Pattern
A Bearish Engulfing candlestick pattern is a bearish reversal candlestick pattern. So when all the requirements are met for a Bearish Engulfing candlestick pattern, I know that the uptrend for the stock’s share price is most likely over or close to over.
Investors and traders alike are enjoying an uptrend in a stock’s share price, and think the jubilance continues is going to continue as the next candlestick pattern starts off with a gap-up at the beginning of the trading period. But that gap-up is met with a lot of selling pressure and the share price continues to decline throughout the trading session and eventually closes below the previous candlestick’s real body.
The development of this candlestick pattern indicates it is time to lock in some profits if you are currently sitting on gains. Otherwise, those gains will most likely begin to erode over the next several trading sessions. Gains tend to erode very rapidly during a downtrend, therefore quick action is often needed once this candlestick pattern is identified.
If you are not sitting on gains, either be ready to sit through a consolidation period or take the loss. It depends upon your personal time-frame, financial position and other factors like tax gain/ loss harvesting.
Requirements
Listed below are the requirements for a Bearish Engulfing candlestick pattern.
- A Bearish Engulfing candlestick pattern always has a red colored real body
- It opens above the preceding candlestick’s real body and closes below it, appearing to “engulf” the previous candlestick
- It is not necessary to “engulf” the upper and/or lower shadows of the previous candlestick too, only the real body is required
Characteristics & Observations
These are some of the characteristics of Bearish Engulfing candlestick patterns, as well as some of my observations.[s2If !current_user_can(access_s2member_level1)]…..
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- The longer the uptrend is that leads up to a Bearish Engulfing candlestick pattern, the better the chances are for the uptrend to end and a downtrend to begin
- When a Bearish Engulfing candlestick develops on volume that is greater than the previous candlestick’s volume, the likelihood just increased that the uptrend is over and a downtrend is about to begin
- A Bearish Engulfing candlestick that develops near a resistance area from another type of technical analysis, say like a trendline, signals a higher degree of probability that the overhead resistance will be strong and the first re-test of the resistance area will usually fail
- From an Elliott wave perspective, there is a good chance that a Bearish Engulfing candlestick pattern that develops on heavier than normal selling volume represents the top of either Wave 3 or Wave 5 in a Bullish Impulse wave pattern, meaning there is not much room, if any, left to the upside for the price
- When a Bearish Engulfing candlestick engulfs the entire preceding candlestick, including the upper and lower shadows, it is an extremely bearish candlestick pattern that is already very bearish; this means that there will be a strong reversal to the downside and also very stiff resistance on any test of the candlestick’s resistance area
Bullish Counter-Part
The bullish counterpart to the Bearish Engulfing candlestick pattern is the Bullish Engulfing candlestick pattern.
The differences between Bearish Engulfing candlesticks and Bullish Engulfing candlesticks is that a Bearish Engulfing candlestick develops at the top of an uptrend while a Bullish Engulfing candlestick develops at the bottom of a downtrend.
Engulfing candlestick patterns, both bullish and bearish, are significant reversal signals that almost always signal that the top or bottom is near or has already been set and the reversal is underway.
Resistance Area
This next illustration shows the resistance area for a Bearish Engulfing candlestick pattern. The resistance area is defined as the very top of the upper shadow for the Bearish Engulfing Candlestick.
Similar to other resistance areas, in order to break through and close above a resistance area from a Bearish Engulfing candlestick pattern, a significant increase in buying volume is most likely necessary.
If a subsequent candlestick can successfully close above the resistance area from the Bearish Engulfing candlestick pattern, the resistance area is considered voided and quick increases in the stock’s share price are likely to follow. This is the exception though, not the norm. Instead, do not anticipate a break above the resistance area on the 1st attempt. The 2nd attempt is suspect at times too. As they say though, the 3rd time is usually the charm.
Trading Strategies
I will review 2 different trading strategies for a bearish reversal candlestick pattern. The first strategy will review scaling-out of a position that you hold when the candlestick pattern develops. The second and more aggressive strategy will involve entering into a short sale position based on further anticipated declines in the share price.
Always be sure to step back and analyze the “trend of one larger degree“. This can help you determine if the pullback is going to be shorter-term in nature or if it is the start of something extremely more bearish in nature.
If You Are Currently Long the Stock
You may have noticed other sell signals flashing before the development of the Bearish Engulfing candlestick pattern. If you did and already scaled out of a few shares, congratulations. If that is not the case and you are still holding all your shares, you will want to begin a scale-out process. Use the very first re-test of the resistance area as an opportunity to make a scale-out sale.
If the re-test of the resistance area fails, as it usually does on the first re-test, another scale-out sale could be made. That would leave you with about 1/3 of your holdings left. I prefer to use a 3 step scale-out process. If you want to be sure to lock in gains at higher prices, you can be more aggressive and use a 2 step scale-out process. You can determine what you want to do with the last 1/3.
One thing to keep in mind is the scale of the chart where you see the Bearish Engulfing candlestick. Is it a daily chart? Is it a monthly chart? The scale of the chart will help to determine the speed in which your selling actions need to take place.
For example, if you notice a Bearish Engulfing candlestick pattern develop on a monthly candlestick chart, you may have 1-3 weeks to execute the scale-out process and try to maximize profits. But be quick because a larger drop is coming. When a Bearish Engulfing candlestick pattern develops on a daily candlestick chart, you may between 1-3 days to execute the scale out process.
It is very important to keep everything in perspective based the scale of the chart you are analyzing. Also use other technical analysis methods for confirmation rather than relying on the candlestick pattern by itself. These other method can help to provide additional areas that can be used as scale-out areas once the downtrend is confirmed.
If You Are Looking to Short the Stock
When a Bearish Engulfing candlestick develops and has a very large amount of selling volume associated with it, this could be an opportunity for aggressive investors and traders to short the stock. Picture the perfect short set-up. A capitulating volume spike, like a climax volume spike, that develops at the top of a long uptrend for a Bearish Engulfing candlestick. Start building the short position as the price attempts to re-test the resistance area from the candlestick.
Ensure the selling volume and selling momentum are both increasing. A MACD Histogram is a great tool to use when monitoring buying and selling momentum. Make sure there is an increase in the selling momentum after the development of the Bearish Harami candlestick pattern. Any slow down in selling momentum is an early indicator to start analyzing the charts and thinking about locking in short sale profits. This is simply done by purchasing shares to cover the shares sold short.
Since prices tend to move down quicker than they move up, short selling can be a very profitable trading strategy. However, it does carry the additional risk of “unlimited losses” when compared to going long on a stock. You need to know when to lock in losses in order to be a successful short seller. If you have a hard time selling anything for a loss, don’t use short-selling as a strategy. If you are not quick to pull the trigger on a loss, that loss can start leading to exponentially larger losses.
In order to minimize risk on a short position, only enter into a short sale trade after capitulating buying volume takes place. Look for a Climax Top volume spike. A capitulating volume spike helps to confirm the bearishness of a Bearish Engulfing candlestick pattern.
Stop-Loss on Short Sale
To try and further minimize risk, a stop-loss order should be used on all short trading strategies. For a Bearish Engulfing candlestick pattern, place the stop-loss order in 1 of 2 places:
- at the resistance area from the pattern as described above
- place a tighter stop-loss order just slightly above the 61.8% retracement of the Bearish Engulfing candlestick itself
Any meaningful downtrend should probably start within the next candlestick or two, especially after a Bearish Engulfing candlestick pattern just formed on heavier than normal selling volume. Look for the selling volume to start increasing along with an increase in selling momentum as indicated by the MACD Histogram chart tool.
Real Chart Examples
This first chart shows a Bearish Engulfing candlestick that developed on a 5 year monthly candlestick chart for Facebook (FB). This candlestick met all the requirements and characteristics I’ve listed above.
A Dark Cloud Cover Candlestick Pattern Developed at the Top of a Long, Extended Uptrend for Facebook – Time to Sell?
When the selling volume for the Bearish Engulfing candlestick is larger than the previous candlestick’s volume bar, the chances for a bearish reversal increase in likelihood. That means the current uptrend is over or really close to the end. The selling volume associated with Facebook’s Bearish Engulfing candlestick was significantly above average, a definite bearish signal.
Also, this bearish reversal signal comes after another bearish reversal signal almost a year earlier. The closing share price for Facebook’s Bearish Engulfing candlestick pattern’s share price closed right on the resistance area from the Dark Cloud Cover candlestick pattern.
Once you break above a resistance area, that area is supposed to become a support area. The resistance area from the Dark Cloud Cover candlestick pattern seems to have provided temporary support. However Facebook’s share price closed below the new support area at the end of December. While the close below the support was on decreasing selling volume, the break back below the support area needs to be monitored closely if you hold shares of Facebook.
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