FP Markets

Bearish Engulfing Pattern

In this segment of our series on technical chart patterns, we delve deeper into the intricacies of the Bearish Engulfing Pattern. This pattern, regularly featured in technical analyses, is a tool often employed to forecast potential price declines.

The Bearish Engulfing Pattern is characterized by a small up (white or green) candlestick, swiftly followed by a larger down (black or red) candlestick that 'engulfs' the preceding up candlestick, signaling an imminent shift in price dynamics. In the context of a chart, this pattern materializes as a sign of sellers gaining an upper hand over buyers, thereby pushing the price downwards more aggressively than the buyers were pushing it upwards. Let's explore the interpretations, and limitations of this pattern in further detail.

What Does It Tell You?

The Bearish Engulfing Pattern is a noteworthy indicator to spot at the tail end of upward price movements. The appearance of this pattern suggests a turn of the tide, indicating a potential shift towards lower prices. The reliability of this pattern is enhanced when the opening price of the engulfing candle sits well above the closing price of the initial candle, and when the closing price of the engulfing candle lies well below the opening price of the first candle. In essence, the larger the down candle, the stronger the signal it sends.

This pattern is particularly reliable when it follows a clean upward movement. If the price action is uneven or ranging, the pattern's occurrence may not necessarily result in significant price changes. Therefore, the overall trend of the price plays a crucial role in determining the usefulness of the Bearish Engulfing Pattern.

Traders usually wait for the second candle to close before making their move on the subsequent candle. Actions may include selling a long position once the pattern appears, or potentially initiating a short position. However, it's essential for traders to consider the overall market context when using this pattern. For instance, if the overall trend is up and robust, it might not be prudent to go short, even if a Bearish Engulfing Pattern forms. Conversely, if the overall trend is down, a Bearish Engulfing Pattern appearing after a pullback to the upside could present a promising opportunity for a short trade.

Practical Application: Using the Bearish Engulfing Pattern

To put this pattern into practical use, consider the example of its occurrence in the forex market. The chart shows three instances of the Bearish Engulfing Pattern. The first pattern appears during a pullback to the upside within a broader downtrend, followed by a decrease in price after the pattern.

The next two patterns, however, are less significant given the broader context. The forex pair's price range begins to narrow, indicating choppy trading conditions, and there's minimal upward price movement before the formation of the patterns. In such cases, a reversal pattern like the Bearish Engulfing Pattern may not be as effective since there's less price action to reverse.

It's important to remember that while Bearish Engulfing Patterns can occur frequently in choppy markets and within ranges, they aren't always reliable trading signals in these conditions. The key to successful application lies in understanding the larger market context and trend​.

Comparing Bearish and Bullish Engulfing Patterns

When we talk about Bearish Engulfing Patterns, it's valuable to understand their counterpart: Bullish Engulfing Patterns. Essentially, these two patterns are diametrically opposite. A Bullish Engulfing Pattern emerges after a price move lower and signals a potential increase in prices.

The first candle in the Bullish Engulfing Pattern is a down candle, followed by a larger up candle. The body of the second (up) candle completely engulfs the smaller down candle. By understanding both patterns, traders can better navigate the shifts in market dynamics, whether they point to a potential decrease (Bearish Engulfing Pattern) or an increase (Bullish Engulfing Pattern) in prices.

Recognizing the Limitations of the Bearish Engulfing Pattern

It's vital to acknowledge that while the Bearish Engulfing Pattern can serve as a useful tool for anticipating potential price declines, it does come with its set of limitations. The usefulness of this pattern is most pronounced following a clear upward price movement as it effectively showcases the shift in momentum to the downside. However, in a choppy price environment, even if there's an overall upward trend, the significance of the pattern might be diminished as it becomes a relatively common signal.

Another factor to consider is the potential size of the engulfing or second candle. If this candle is exceptionally large, it could leave a trader with an overly significant stop loss if they choose to trade the pattern. In such scenarios, the potential reward from the trade might not warrant the risk involved.

Finally, determining the potential reward can also be challenging with engulfing patterns as candlesticks don't provide a price target. Traders might need to employ other methods, such as indicators or trend analysis, to select a price target or decide when to exit a profitable trade. This highlights the importance of using the Bearish Engulfing Pattern in conjunction with other indicators and considering the broader market picture.