How to trade Bearish Engulfing Candlesticks with Example: FKnol.com

The bearish engulfing candlestick pattern is a regularly occurring pattern on the price charts of stocks, ETFs and stock market indexes. Forming usually on the upward trending stock prices, its formation is a strong signal for a potential reversal of the ongoing upward trend in the prices of the security and leads to price decline. When the bearish engulfing is formed when the price is in uptrend, then the price may start to move down after the formation of the bearish engulfing pattern. Being a two-line pattern, one must look for the formation over two periods of the candlesticks.

Formation of the bearish engulfing candlestick is very common in the market. It is also considered a strong signal, which has a good rate of success if followed properly. To understand the working and trading of the bearish engulfing candlestick, let's start by checking the factors needed for its formation.

Construction of the Bearish Engulfing Candlestick

The bearish engulfing candlestick is formed by two adjacent candles. The first candle is a green-colored bullish candle which is a part of an uptrend. After few such green candles, one may observe that a bearish red candle larger in size than its immediately previous red candle is formed. This constitutes the bearish engulfing pattern. This first green candle can even be any doji candle which has zero or very little body length.
However, the second green candle that follows, which is actually known as the engulfing candle, is a red-colored bullish candle and has its close price lower than the open price. Additionally, this second candle is also considerably larger than the previous one, and in a way 'engulfs' the previous one, hence the name of the pattern is engulfing pattern. Since this second candle needs to engulf the previous one, it cannot be a doji candle. The lengths of the wicks (also called candle shadows) may not have any significance - only the bodies of the two candles which are constituted by open and low prices matter. As one can see from the latest examples mentioned in the next section, the second candle completely engulfs the first one.

The body of the first candle should lie somewhere within the range of the second candle. It indicates that the engulfing requirement is limited to the bodies of the two candles, and does not apply to their wicks or shadows which may exceed the total length.

The next requirement for a reliable bearish engulfing pattern is that it should form during an established uptrend. Formation of a large red-colored bearish candle indicates that the price reversal is possible, and the trend of the green-colored candles is expected to come to a halt. Although the bearish engulfing is considered to be a strong signal, many traders often wait for a confirmation candle to form which should also be red in color. If that happens, it further confirms the notion that uptrend has ended and the downtrend has gained momentum. Its time to go short on the stock, or cut the losses if already holding a long position. However, those who wait for the confirmation may lose out on shorting the stock at a lower price and consequently miss out to reap higher returns. Whether to wait for the confirmation candle or act on the formation of the engulfing pattern remains a choice of the individual trader. With experience, traders get stock-specific confidence to directly take positions after the formation of the bearish candle. This is how a typical bearish engulfing candlestick appears:

Trading the Bearish Engulfing Candlestick

The bearish engulfing forms very often on the price charts of all kinds of assets - be it stocks, indexes or exchange-traded funds (ETFs). Its formation on the continued uptrend indicates that the bulls (buyers) have been having a good control over the bears (sellers) and they were ruling the market till now as indicated by several green candles being formed during the uptrend. However, the formation of the large length bearish red-colored candle indicates that bulls are getting outnumbered and losing out to the bears, which has resulted in the formation of the red-colored bearish candle much lengthier in size compared to the previous bearish candle. Since this candle is larger in size than the previous one, it means that the prices were pulled down massively by the sellers - the price opened at higher level than the previous close, and went pulled down to even lower than the previous open.
The formation of the red-colored confirmation candle further supports the bears taking to the driving wheel of the prices, and are pulling down the prices. Hence, its time to go short - that is, sell the stock, or cut the losses if holding a long position.

Bearish engulfing candle gains significance when formed during the uptrend. The formation sets the tone for a potential reversal after a long uptrend in the stock prices, especially when the length of the red candle is long enough relative to the earlier green candle.

Additionally, traders may also look for the location of bearish engulfing pattern formation. The lower the first green-candle is placed compared to the red-candle's body, the stronger the reversal signal. Traders enter the trade when the bearish engulfing is formed at the upper Bollinger band breakout, or at the breakout of the trend-line (like 200-day moving average), or similar other range breakouts. The larger the breakout indicated by the length of the red candlestick, the stronger the reversal pattern. If the bearish engulfing is formed in the middle Bollinger band or far away from the trend-line (without breaching the trend-line), then the traders may not consider it as a strong reversal signal and they avoid the trade. When formed around the middle band or away from the breakout range, the bearish engulfing often leads to continuation of the existing trend instead of a reversal.

Trading Scenario for Bearish Engulfing

Here are the general considerations and scenrio for trading the bearish engulfing candlestick.

▶ Trade Entry: Formation of bearish engulfing during an uptrend is taken as a sign of reversal, that is - the market prices are expected to go down in near future. So traders try to take a short position at or around the high price of the bearish engulfing candle. However, as many traders like to wait for the confirmation candle to form, the sell price may be lower as the trend has already kicked in taking the prices downward. That's the tradeoff one needs to accomodate for.

▶ Stop-loss Limit: The stop-loss varies from trader to trader based on their individual trade preferences, but usually while going long they set the stop-loss at 2-3 units above the high price of the bearish engulfing candle. Others who enter at a lower price may like to adjust the stop-loss accordingly.

▶ Profit-levels: While active trading at short intervals, traders must follow a risk-reward ratio to determine the possible profit level from their bearish engulfing pattern trading. For instance, if the stop-loss limit is set at $1 (the maximum loss one is willing to take on a trade) and the risk-reward ratio one follows is 1/2, then one must take profits when it hits $2. If the risk-reward ratio being followed is 1/3, then one must aim for profits when the price hits a level that generated $3 for every $1 stop-loss set.

▶ Market Conditions: More volatile stocks with high beta values often tend to have high occurrences of bearish engulfing formations. Therefore, suitable selection of stocks/ ETFs / indexes is important while taking on bearish engulfing-based trading. Along with the above mentioned bearish engulfing formation requirement, traders should ensure that their selected price range, bands or trend-line limits are getting breached with large moves of the second bearish (and subsequent) candle. This ensures higher success rate of profitability. Although one must note that trading on technical analysis like candlestick patterns has limited success rate, so following strict stop-loss, disciplined trading and efficient capital management is advised.

Example of Bearish Engulfing Candlestick

The following chart shows an instance of bearish engulfing candlesticks and the uptrend that followed shortly after:

As one can observe, the formation of the bearish engulfing candle reversed the uptrend that preceded the first green candle, and led to a downward move indicated by the long red arrow. The trend reversal was also confirmed by another red candle which formed immediately after the formation of the bearish engulfing candle, and was located considerably above the first bearish engulfing candle indicating a confirmation for the down move.
Traders usually set their profit targets and stop-loss levels based on the risk-reward ratio of their choice as mentioned in the previous section.

Latest Bearish Engulfing Formations

FKnol.com has a dedicated section on candlesticks where the list of stocks, ETFs and indexes forming bearish engulfing candles is updated on a daily basis. At present, the following are three examples - one each from stocks, ETFs and indexes - which have formed the bearish engulfings as of the mentioned date (in reverse chronological order):
1) On Friday, Oct 23, 2020, the stock price of Finance sector based Mastercard Inc. (MA) formed the following Bearish Engulfing Candlestick pattern:

Day	Open	Close	Body Length
Today's	$335.69	$329.61	$6.08
Previous Day's	$333.37	$333.60	$0.23
Today to Previous Day's Body Length Factor:			26.43

		$335.69
$333.60
$333.37
		$329.61

See full details and past history of Bearish Engulfing Candlesticks for Mastercard (MA)

▶ Full list of stocks which most recently formed the Bearish Engulfing Pattern

2) On Friday, Oct 23, 2020, the price of Energy based United States Oil Fund (USO) ETF formed the following Bearish Engulfing Candlestick pattern:

Day	Open	Close	Body Length
Today's	$28.55	$27.88	$0.67
Previous Day's	$28.30	$28.51	$0.21
Today to Previous Day's Body Length Factor:			3.19

		$28.55
$28.51
$28.30
		$27.88

See full details and past history of Bearish Engulfing Candlesticks for United States Oil Fund (USO)

▶ Full list of ETFs which most recently formed the Bearish Engulfing Pattern

▶ Full list of Market Indexes which most recently formed the Bearish Engulfing Pattern

...and there's more. FKnol.com everyday checks the stock price and candlestick formation across hundreds of stocks, ETFs and indexes to look for bearish engulfing formations. Please see the full list of recent bearish engulfing formations for:
▶ Full list of recent Bearish Engulfing Stocks
▶ Full list of recent Bearish Engulfing ETFs
▶ Full list of recent Bearish Engulfing Indexes

The Bottom Line

Trading candlesticks like the bearish engulfing needs strict discipline and emotion-free trading. Candlestick trading is a part of technical analysis and success rate may vary depending upon the type of stock selected and the overall market conditions. Use of proper stop-loss, profit level and capital management is advised.
One can also explore the similar candlestick formations on various dates using the below screener:

Search Bearish Engulfing Candles for a particular: