Bearish Engulfing Pattern

Bearish Engulfing Pattern Properties

Let’s think about the two sessions that make up our pattern. On day one the market goes up, as evidenced by the open bodied candlestick. The market is in an uptrend, so this is no surprise, and by the end of this session all’s well in the world if you’re bullish.

On the second session the market opened stronger, above the previous day’s close, so once again things are going well if you’re long. But then it all changes; the sellers are resurgent, and by the end of this session the market has sold off. The filled real body that surrounds or engulfs the open real body preceding it means enough has been sold off to give back all of the gains made the day before, and a bit more. From the first day’s open to the second day’s close the market is lower, having been a lot higher in between times.

So there is an arc shaped direction of travel, a rise then a drop, and a weak close to boot.

Engulfing patterns versus outside days

There is a pattern in Western analysis called a bearish outside day, or a key reversal day. The rule set for this is a bear day in a rising market with a high above the previous day’s high and a low below the previous day’s low. In other words the day’s range is outside that of the day before, and a weak close is posted. This is pretty similar to an Engulfing Pattern, but not always, as the candlestick version doesn’t necessarily require a greater range on day two, just a larger (filled) real body. In other words the range doesn’t have to come into the equation.

Examples

Figure 4-2: AMEC pic; daily candlestick chart; 16 October 2007 - 24 January 2008, showing Bearish Engulfing Pattern on 3 and 4 January

          On the 4 January a key support level was also broken at 820, and the move through here produced a Western Double Top formation as the market broke down through the low from a few sessions previous (24 December 2007). The other thing to note about this chart is how the market failed right on the resistance from a few months before.

Figure 4-3: ICE Brent Crude Oil futures (all sessions, active unadjusted continuation); daily candlestick chart; 30 November 2007 - 11 February 2008, showing 3 and 4 January 2008 Bearish Engulfing Pattern

This Bearish Engulfing Pattern saw a red candle surrounding a Star (see page 9) made the day before. We’d made a new all time high on the first candle of our pattern. Immediately after the Bearish Engulfing Pattern another big red candle was posted, so there was some instant gratification. There was an uptrend line to break before we got too excited though, and you can see there was another solid reaction to the downside once this line gave way. This is an important point to make: even if you had seen the reversal pattern, but then waited for the trend line to break, you still could have made good money on the down move, even if you only started selling $5 off the highs.

My particular favourites are combination patterns where we see something like a Shooting Star that is then engulfed by the next candlestick; the engulfing line adds weight to the initial signal. As always, though, we’d look for confirmation after the event before we’d act.

The ideal world volume characteristics of this pattern is higher volume on the second candlestick, ie, the selling on the second day is more ferocious than the buying that was seen on the first.

Bearish Engulfing Pattern summary

The Bearish Engulfing Pattern is a two candle pattern in a rising market where the second candle has a filled real body that surrounds the open real body before it. This is generally a strong reversal pattern as it often takes a lot of effort and achievement from the bears for it to form. It is one of my particular favourites for this reason. Also it usually coincides with the Western bearish outside day. It should be ignored at your peril!