Explanation of the Bullish Engulfing Candlestick Pattern
A Bullish Engulfing pattern is a two-candlestick formation that signals a potential reversal from a downtrend to an uptrend. It occurs when a small bearish candle is followed by a larger bullish candle, which “engulfs” the body of the previous candle. This pattern suggests that buyers have taken control, indicating a possible shift in market sentiment from bearish to bullish.
Typically, this pattern is used by traders to identify possible buying opportunities, especially when it appears after a prolonged downtrend or near a key support level. It provides a clear sign that momentum might be shifting towards the bulls.
Illustration of Bullish Engulfing Candlestick Pattern
The Bullish Engulfing candlestick pattern is illustrated below.
Key Pattern Features
- Appears after a downtrend.
- Consists of two candles: the first one is bearish, and the second one is bullish.
- The second (bullish) candle fully engulfs the body of the first (bearish) candle.
- Indicates strong buying pressure, signaling a potential reversal.
Trading Psychology of Bullish Engulfing Pattern
The Bullish Engulfing pattern reflects a clear shift in market sentiment. Initially, sellers are in control, but the larger bullish candle demonstrates that buyers have overpowered them, taking control of the market. This transition signifies a growing confidence among buyers, leading to an increased likelihood of a bullish reversal.
In different market contexts, a Bullish Engulfing pattern may indicate the start of a new uptrend, especially when it forms after a significant downtrend. The pattern shows that buying pressure is outweighing selling pressure, potentially driving prices higher.
Conventional Approach to Using Bullish Engulfing Pattern
Market Conditions: The Bullish Engulfing pattern is more likely to succeed in trending markets, particularly during a downtrend as it signals potential reversal. In high-volatility environments, the pattern may perform better as volatility increases the likelihood of significant price moves. In contrast, during low volatility or sideways markets, the strength of the signal may weaken.
Risk Management Suggestions
Systematic traders often place stop-losses below the low of the engulfing pattern. This provides a safeguard against false signals or if the market continues its downtrend. However, these stop-loss levels should always be backtested and adjusted according to the trader’s risk tolerance and market conditions.
Backtest Performance
The following analysis shows the average profit per trade from purchasing selected ETFs on the open after the bullish 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
The Bullish Engulfing pattern may fail when it occurs in weak market conditions or during consolidation periods. If the second candle does not exhibit strong bullish momentum or volume, it could indicate a false signal. Additionally, the pattern may fail if it occurs too early within a prolonged downtrend or near a strong resistance zone, where selling pressure is likely to reassert itself.
Systematic Trading Application
Traders can use the Bullish Engulfing pattern as part of a systematic trading system by setting clear entry and exit rules. For example, an entry could be triggered on the day after the engulfing pattern completes, when the price breaks above the high of the bullish engulfing candle. A potential exit strategy could involve a trailing stop based on a moving average or other technical indicators. Backtesting these rules on historical data is essential to determine their effectiveness in various market conditions.
Amibroker Code for Bullish Engulfing Candlestick Pattern
// Amibroker AFL Code for Bullish Engulfing Pattern
bearishCandle = Close < Open;
bullishCandle = Close > Open;
engulfingPattern = Ref(bearishCandle, -1) AND bullishCandle AND Close > Ref(Open, -1) AND Open < Ref(Close, -1);
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