Explanation of Bearish Engulfing Candlestick Pattern
The Bearish Engulfing candlestick pattern is a two-candle reversal pattern that typically signals a bearish trend following an upward movement. It forms when a smaller bullish (upward) candle is immediately followed by a larger bearish (downward) candle, which “engulfs” the previous candle’s body. This pattern suggests that selling pressure has overwhelmed buying pressure, indicating potential further downside. It’s commonly used by traders to anticipate reversals in uptrending markets, and it’s seen as a strong signal when it occurs at the top of an uptrend or resistance level.
Illustration of Bearish Engulfing Candlestick Pattern
The Bearish Engulfing candlestick pattern is illustrated below:
Key Pattern Features
- A small bullish candle followed by a large bearish candle.
- The bearish candle’s body engulfs the entire body of the preceding bullish candle.
- It occurs at the top of an uptrend, signaling potential reversal.
- Stronger when accompanied by higher volume on the bearish candle.
Trading Psychology of Bearish Engulfing Pattern
The Bearish Engulfing pattern reveals a shift in market sentiment from bullish to bearish. On Day 1, buyers push prices higher, showing optimism. However, on Day 2, sellers take control, completely overwhelming buyers, as reflected by the larger bearish candle. This sudden change suggests that the bulls are losing momentum, and traders who were betting on a continued uptrend may start closing their positions, leading to more downward pressure. This psychology typically leads to a bearish reversal, especially when it forms after a prolonged uptrend.
Conventional Approach to Using Bearish Engulfing Pattern
- Market Conditions: The Bearish Engulfing pattern is more effective in trending markets, particularly at the end of an upward trend. It is believed to perform better in markets with medium to high volatility, where swift sentiment changes are common. The pattern is less reliable in sideways markets where price fluctuations are minimal.
- Volatility: In higher volatility environments, the pattern’s reversal signal is considered stronger, as it indicates a decisive shift in market sentiment.
Risk Management Suggestions
For systematic traders, stop-losses are typically placed just above the high of the second (bearish) candle. This helps protect against false signals if the trend does not reverse as expected. It’s crucial to backtest this strategy across different markets and conditions before trading live, to ensure it aligns with your risk tolerance.
Backtest Performance
The following analysis shows the average profit per trade from purchasing selected ETFs on the open after the bearish engulfing pattern is formed assuming the trade is held for 5 trading days. The scenarios covered include:
- Primary Bull (Bear) Market: Close above (below) the 200 day simple moving average
- Short Term Strength (Weakness): Close above (below) the 20 bar simple moving average
- Low (High) Volatility: 20 bar Average True Range/Close is below (above) the 200 day moving average of the same
The purpose of this is to determine quickly whether the pattern holds any edge as an entry for these ETF’s. Obviously there are many ways to test this and I would suggest you test the pattern in your own backtesting.
All numbers presented represent average percent gain over the 5 days following the signal with no other exits. Darker green areas represent larger positive edge, darker red indicates potential areas edge on the short side.
Pattern Failure Conditions
Common failure scenarios for the Bearish Engulfing pattern include:
- The pattern forming in sideways or choppy markets, where the price may continue in its previous direction.
- Occurrence in low-volume conditions, which might indicate that the engulfing candle does not reflect widespread selling.
- Following a sharp, short-term pullback within a broader uptrend, where the bearish signal might be a false alarm.
Systematic Trading Application
In a systematic trading approach, the Bearish Engulfing pattern could be used as an entry signal for a short trade. A typical setup might include entering a short position at the close of the engulfing candle, with a stop loss set just above the high of the second candle. Exit rules could be based on a predetermined profit target or trailing stop-loss to capture more of the potential downward movement. All such strategies should be backtested across historical data to verify their efficacy.
Amibroker Code for Bearish Engulfing Pattern
// Bearish Engulfing Pattern
bearishEngulfing = (Ref(Close,-1)>Ref(Open,-1) AND // First candle is bullish
Open < Ref(Close,-1) AND // Second candle opens higher
Close < Ref(Open,-1) AND // Second candle closes below first candle’s open
Close < Open); // Second candle is bearish
Links to Articles About Other Candlestick Patterns
Explore more candlestick patterns and enhance your trading strategy! Visit our Ultimate Candlestick Pattern Guide or explore individual patterns below:
- Doji
- Hammer
- Inverted Hammer
- Bullish Engulfing
- Bearish Engulfing
- Morning Star
- Evening Star
- Shooting Star
- Hanging Man
- Piercing Pattern
- Dark Cloud Cover
- Three White Soldiers
- Three Black Crows
- Dragonfly Doji
- Gravestone Doji
- Spinning Top
- Marubozu
- Tweezer Top
- Tweezer Bottom
- Bullish Harami
- Bearish Harami
- Rising Three Methods
- Falling Three Methods
- Bullish Abandoned Baby
- Bearish Abandoned Baby
- Bullish Kicker
- Bearish Kicker
- Three Inside Up
- Three Inside Down
- Upside Gap Two Crows
- Mat Hold
- Upside Tasuki Gap
- Downside Tasuki Gap