Bearish Engulfing Pattern

ENGULFING PATTERNS

BEARISH ENGULFING

Description

The Bearish Engulfing signal is exactly opposite the Bullish Engulfing signal. The Bearish Engulfing pattern is a major reversal pattern comprised of two opposite-colored bodies. The Bearish Engulfing Pattern (Figure 2-23) is formed after an uptrend. It opens higher than the previous day's close and closes lower than the previous days open. Thus, the black candle completely engulfs the previous day's white candle. Engulfing can include either the open or the close being equal to the open or close of the previous day but not both.

Criteria

1.     The body of the second day completely engulfs the body of the first day. Shadows are not a consideration.

2.    Prices have been in a definable uptrend, even if it has been short term.

3.    The body of the second candle is opposite color of the first candle, the first candle being the color of the previous trend. The exception to this rule is when the engulfed body is a Doji or an extremely small body.

Signal Enhancements

1.     A large body engulfing a small bod); The previous day was showing the trend was running out of steam. The large body 2. shows that the new direc­tion has started with good force.

2.    When the engulfing pattern occurs after a fast spike up, there will less supply of stock to slow down the reversal move. A fast move makes a stock price over-extended and increases the potential for profit taking and a meaningful pullback.

3.    Large volume on the engulfing day increases the chances that a blow-off day has occurred.

4.    The engulfing body engulfing more than one previous body demonstrates power in the reversal.

5.    If the engulfing body engulfs the body and the shadows of the previous day, the reversal has a greater probability of working.

6.    The greater the open price gaps up from the previous close, the greater the probability of a strong reversal.

The Bearish Engulfing signal is created with the same investor psychology as the Bullish Engulfing signal. After an uptrend, the open of the Bearish Engulf­ing signal is above the close of the previous day’s bullish body. Once again, the investor psychology that illustrates exuberance, began the formation. A Bear­ish Engulfing signal requires only to have an open above the previous days close. The demonstration of exuberant buying, an open price much higher than the previous day’s close and/or above the previous day’s trading range is more significant. Where do most investors buy? Exuberantly at the top!

The further to the upside that the Bearish Engulfing signal opens, the more convincing the Bearish Engulfing signal becomes. It clearly illustrates that the Bears have now taken over control of the trend. As with the Bullish Engulfing signal, the Bearish Engulfing signal is visually clear to identify. It is a dark candle after an uptrend of bullish candles.

A Bearish Engulfing signal following another candlestick sell signal adds more conviction to a downside move. As illustrated in Fig. 2-28 the Novatel Wireless Inc. chart, the Bearish Engulfing signal is initially created with a gap- up in overbought conditions.

A gap-up in price, followed the Doji/Spinning Top formation of the previous day. The bearish trading of that day confirms the indecision that was develop­ing in the previous day’s signal. As with all the major signals, the signal itself is the most important factor. Confirming indicators, such as stochastics, are just that, confirming indicators.

The Bearish Engulfing signal witnessed in Fig. 2-29 (following page), the Abgenix chart, occurred at a significant level. Although the stochastics were not near an overbought condition, a Bearish Engulfing signal occurring exactly at the 200-day moving average is meaningful.

It clearly illustrated that the sellers made their presence known once an impor­tant resistance level had been touched

A Bearish Engulfing signal gains more credibility after witnessing the ob­vious topping signals of a trend. Notice in fig. 2-30, the Sonic Solutions chart (following page), the uptrend shows topping signals with a gap up in the over­bought condition. This would be the area to start looking for a candlestick sell signal. The formation of the Bearish Engulfing signal, the following day, is more relevant after the gap-up. The second Bearish Engulfing signal four days later reaffirms that the sellers have come into this price. Both long dark candles provide more evidence that the sellers are now in control.

The Bearish Engulfing signal can be created by opening higher than the previ­ous day’s close. If the open is higher than the previous day’s trading range, stop- loss procedures can easily be implemented. Stop-loss procedures will be fur­ther discussed in the Entry and Exit Strategy chapter. The completion of a Bearish Engulfing signal, in an overbought condition, allows investors to pre­pare for short trade potentials.

Notice in Fig. 2-31, the Millicom International Cellular chart, the gap up in the overbought condition was the first indication of a bearish signal being formed. A ‘close’ below the previous days open, as well as the open on the candle two days prior, made for a strong Bearish Engulfing signal. Not only should this have closed out any long positions, it should have set the stage for shorting the stock.

The Bearish Engulfing signal portrays the same characteristics as found in the Bullish Engulfing signal. A Bearish Engulfing signal viewed in an overbought condition projects an extremely high probability of the trend turning down. What happens when a Bearish Engulfing signal is seen in an oversold condi­tion? As with the Bullish Engulfing signal viewed in the overbought condition, representing last gasp buying, a Bearish Engulfing signal provides the same alert. A Bearish Engulfing signal in an oversold condition demonstrates the final selling.

When viewing a Bearish Engulfing signal in oversold condition, an investor should be prepared for a bullish signal to occur very soon. As an alert for the bull to start watching for a buy signal, it should also forewarn the investor with a short position to be prepared to cover as seen in Fig. 2-32, the Google chart

The Bullish and the Bearish Engulfing signals are both highly effective candle­stick signals.

They can easily be recognized visually on a chart. Incorporating investor psychology that is built into those signals allows the candlestick investor to take advantage of tread reversals at the most opportune rimes. The signals, occurring in overbought or oversold conditions, make their effectiveness that much greater. The engulfing patterns reveal a significant change in investor sentiment. They should always be addressed. The Bullish and the Bearish En­gulfing signal, occurring at other major technical levels, provide a significant meaning. Do not ignore these signals.