Last Updated on 21 September, 2020 by Samuelsson
Having attracted many traders since its introduction to the western world in the late ’80s, the candlestick chart is now ubiquitous and known by most traders. In addition to being a chart type, candlesticks also form candlestick patterns, and one common candlestick pattern is bearish engulfing.
A bearish engulfing is a two-candle bearish reversal pattern that forms after a bullish trend. It indicates that the market is about to turn into a bearish trend, and is made up of one bullish and one bearish candle. The pattern is characterized by the bearish candle that fully engulfs the body of the preceding bearish candle.
In this article, we’re going to cover how you identify a bearish engulfing pattern, what it means, and provide some example trading strategies.
How to Identify a Bearish Engulfing Pattern
The bearish engulfing is a bearish reversal pattern, and as such, it’s most logical to look for it after the market has gone up for some time. Then there is a bullish trend that can be turned around, which isn’t the case if the market is at new lows when the pattern is forming, just to give an example.
Here is to identify a bearish engulfing candlestick pattern:
- The first of the two candles is bullish
- The second candle is bearish, and engulfs the body of the previous candle.
What Happens in the Market?
Once we see a bearish engulfing in the market, it tells us that the bears have finally won the fight with the bulls and that we’re headed for lower prices.
When the first bullish candle is formed as a part of the ongoing uptrend, it tells us that the bulls still control the market. There is more buying pressure than selling pressure, which is an indication that the market will continue to head higher.
On the open of the next bar, sellers are nowhere to be seen, and the market opens higher than it closed. However, out of fear that the market has gone up too much, selling pressure starts to build up, and pushes price lower. Once the day is over, bears have managed to make the market close below the open of the previous bar, which signals that the uptrend might be over for this time.
In essence, what makes the bearish engulfing pattern a reversal pattern is the swift changes that occur within the last candle.
Examples of Bearish Engulfing
Here follow two examples of the bearish engulfing pattern:
Ways of Enhancing the Bearish Engulfing Pattern
There are many traders who mean that the bearish engulfing pattern can’t be traded as is. It must be applied to the right market and timeframe, since it won’t work everywhere as many want it to seem. You also might want to use some sort of filter, to improve the accuracy of the signal.
Below we’re sharing a couple of ways that you go about to increase the accuracy and profitability of a bearish engulfing signal. Remember that what works depends on the market and timeframe. The conditions outlined below are meant more as inspiration!
Volume is a great market sentiment indicator that nicely complements price data. While price data shows you the movements of the market, volume shows the conviction with which the market carried out those movements. Using volume the right way can provide good clues as to whether a signal is worth taking or not.
Now, there are several ways you could go about here. However, one common way is to demand the volume of the bars comprising the pattern to be higher than that of the surrounding candles. That way we ensure that many market participants took part in forming the pattern, which in theory should make the pattern more accurate.
However, you could also look at the volume of the two candles relative to one another. If the bearish candle has much greater volume than the first bullish candle, then that might be a sign that the market strength is abating.
2. The Range of the Candles
As with volume, the range of a candle could be a good indication of the conviction of the market. If the range is small, then the market is hesitant and tentative. However, if it’s big, then that shows that the market acted with strength.
Now, in the case of the bearish engulfing pattern, you could demand that the range of the pattern as a whole is significantly bigger than the ranges of the surrounding candles. Another way could be to require the second bearish candle to have a significantly bigger range than the first bullish bar of the pattern. That way we want to bearish reaction, which we are shorting on, to be much stronger than the preceding bullish candle. This might help us find better signals!
Another thing that often has a significant impact on the performance of many patterns and strategies, is volatility. You will find that some patterns work better with high volatility, while others work better with low volatility.
However, one thing to keep in mind is that volatile markets perform greater swings than less volatile ones. As such, a volatile market could be more likely to give false signals, since it will travel the distance needed to form a bearish engulfing more easily than a market with low volatility!
Bearish Engulfing Strategies
Now it’s time to go on to some strategies that use the bearish engulfing pattern. Even if the bearish engulfing is considered to be a reliable reversal sign, most traders who make use of it do so in combination with some filters or additional conditions.
Below we’re going to show you some examples of what bearish engulfing trading strategies could look like. Just remember that these strategies are not ready for trading, but are mentioned more for inspiration.
1. Bearish Engulfing and RSI
Typically, the bearish engulfing pattern occurs after an uptrend. However, that doesn’t keep it from appearing also when the market, for example, is going down.
Now, in order to ensure that we only take a bearish engulfing if the market has moved up, we could use the RSI indicator. RSI is one of our favorite indicators, and we have many trading strategies that make use of it.
To ensure that the market is towards the overbought spectrum when we enter a trade, we demand that the 5-period RSI is above 50 when the pattern forms. However, we cannot use the RSI reading of the last bar, since the big bearish candle in effect is the start of the new bearish trend, and with great likelihood will push RSI below 80. So instead, we’ll use the RSI reading of the previous bar.
The rules for this strategy become:
- We have a bearish engulfing
- The 5-period RSI, measured on the previous bar, is above 50
And to exit the trade, we use a simple time exit that gets out of the trade after five bars.
2. Bearish Engulfing With Moving Average Profit Target
Since a bearish engulfing should happen after the market has gone up for a while, it means that it will trade above its moving average. And as a consequence, we could make use of the moving average as a profit target.
That’s what we try to do in this strategy.
The rules for this strategy are:
- We have a bearish engulfing.
- The market is above its 10-period moving average
And then we just exit the trade once the market closes below its 10-period moving average.
3. Bearish Engulfing and ADX
As you probably remember, we discussed using market volatility to decide whether we should enter a trade or not.
In this example strategy, we’re using the ADX indicator to enter a trade only if the volatility levels are medium to high. Our definition of those market conditions is that the 14-period ADX is above 20.
Here follow the rules for the strategy. We short the market if:
- There is a bearish engulfing
- 14-period ADX is above 20
To exit the trade we use a simple time exit, and get out of the trade after five bars.
Difference Between Bullish Engulfing and Bearish Engulfing
The bearish engulfing and bullish engulfing patterns could be said to belong to the same family. However, as is apparent from their names, they signal different things.
In contrast to the bearish engulfing pattern, a bullish engulfing shows that a bearish trend might have come to an end. In other words, its the opposite of a bearish engulfing.
Here you can read more about the bullish engulfing pattern!
In this article, we’ve had a look at the bearish engulfing pattern. We’ve explored what it means, how to identify it, and provided some examples of trading strategies that hopefully will spark ideas when you build your own trading strategies!
If you want to learn more about building a trading strategy yourself, we recommend that you read our massive article on how to build a trading strategy!