In this comprehensive guide, traders will learn what the Bearish Engulfing Candlestick Pattern is, how it forms, how to identify it, and the psychology behind its formation. Along with that, we'll discuss the conditions where the accuracy of this pattern is high and the conditions where traders should avoid trading this pattern. Whether you are new to candlestick patterns or a seasoned trader looking to enhance or polish your knowledge, this post will definitely help you understand this pattern effectively.
In the second session, where the bearish candle forms, the market shifts dramatically. The bearish candle opens at or above the previous candle's close, and instead of continuing the bullish momentum, the market turns bearish, leading to the formation of a sharp bearish candle that closes significantly lower than the previous one. This completely engulfs the previous candle and confirms the pattern. The engulfing nature of the bearish candle signals that the sellers have overwhelmed the buyers, indicating that a reversal is likely underway. High trading volume and the larger size of the engulfing candle further strengthen the reliability of this pattern.
Table of Content
What is a Bearish Engulfing Candlestick Pattern?
The Bearish Engulfing Candlestick Pattern is a trend reversal pattern used to reverse an uptrend into a downtrend. It consists of a double candle formation, with the first candle being part of the uptrend and bullish in nature, while the second candle signals the beginning of a downtrend and is bearish in nature. The second bearish candle is significantly larger than the previous bullish candle, and the engulfing of the first candle by the second completes the formation of this pattern. The engulfing action signals that the bears have taken control from the bulls, suggesting that the market is shifting from a bullish to a bearish sentiment. The size of the first candle indicates weak buying momentum or a temporary pause in buying interest, but the sellers take advantage and drive the price downward. The larger the second bearish candle, the greater the reliability of the pattern.How Bearish Engulfing Candlestick Pattern forms?
The Bearish Engulfing Candlestick Pattern forms over two consecutive trading sessions and generally appears at the top of an uptrend or during a consolidation phase in the market. Understanding its formation in the right context helps traders assess potential entry and exit points based on the reversal it signals. The first candlestick, which is bullish, forms with lower trading volume, signaling that the ongoing buying interest is weakening. This indicates limited buyer strength or waning bullish momentum as the market moves. The difference between the opening and closing prices of the first candle tells us that the buyers had some control over the market but couldn't push the price much higher.In the second session, where the bearish candle forms, the market shifts dramatically. The bearish candle opens at or above the previous candle's close, and instead of continuing the bullish momentum, the market turns bearish, leading to the formation of a sharp bearish candle that closes significantly lower than the previous one. This completely engulfs the previous candle and confirms the pattern. The engulfing nature of the bearish candle signals that the sellers have overwhelmed the buyers, indicating that a reversal is likely underway. High trading volume and the larger size of the engulfing candle further strengthen the reliability of this pattern.
How to identify Bearish Engulfing Candlestick Pattern?
Identifying the Bearish Engulfing Candlestick Pattern on a price chart is relatively easy and straightforward, involving a few steps and characteristics that traders should look for.Here's a step-by-step guide to help traders spot this pattern:
Existing Uptrend: The primary condition for identifying this pattern is to ensure its formation during an uptrend or after a prolonged upward move. Since this is a trend reversal candlestick pattern that reverses an uptrend into a downtrend, it is necessary to have a clear uptrend prior to the pattern's formation.
First Candlestick: The pattern consists of two candlesticks, with the first being part of the uptrend. It is bullish in nature, indicating that the bulls were in control during the trading session, but their strength is not enough to sustain the upward move.
Second Candlestick: The key identifying feature of this pattern is the second candle, which signals the initiation of a downtrend. The second candle is bearish (red) and has a significantly larger body than the previous one, fully engulfing the first candle. Some part of the second candle remains larger than the engulfed portion, confirming the pattern.
Gap Up at Open (Optional): Although not always necessary, the second bearish candle may open with a gap up, meaning slightly above the previous candle. This gap strengthens the pattern as it indicates initial optimism by the buyers, followed by a sharp reversal in the market.
Close Below the Previous Candle: The second bearish candle should close significantly below the previous bullish candle. The lower the close, the stronger the pattern is considered. A deep close signals strong selling pressure in the market, increasing the probability of a reversal.
Higher Volume (Optional): Typically, the second candle is accompanied by higher trading volume, as there is significant participation by sellers in the market. Higher volume behind the second candle suggests that there are enough sellers involved to sustain the downtrend initiated by this pattern.
By assessing these criteria, traders can easily identify the Bearish Engulfing Candlestick Pattern on a price chart.
Psychology behind the formation of Bearish Engulfing Candlestick Pattern
The formation of the Bearish Engulfing Candlestick Pattern reflects a critical psychological shift in market sentiment, indicating that a reversal is underway. The pattern initiates with a small bullish candle, representing the buyers' last attempt to push the price higher. Although the candle is small, there is a significant difference between the opening and closing prices of the underlying security, indicating that the bulls are still optimistic about the continuation of the uptrend but lack enough strength to sustain it. As a result, sellers step into the market with significant volume, overwhelming the buyers and leading to a sharp decline in price, forming a heavy bearish candlestick. The sudden and sharp downward move signals that sellers are now in full control, allowing other participants to ride the fall in the market. As more sellers begin to ride the decline, the market moves into a downtrend, and the chances of sustaining that trend increase. Ultimately, this pattern pinpoints the moment when the bulls completely exhaust themselves and sellers begin to dominate the market, leading to a higher likelihood of reversal.How to trade the Bearish Engulfing Candlestick Pattern effectively?
There are a few notable conditions that traders should look for to determine whether they are fulfilled in order to trade this pattern effectively. Before entering any trades based on the formation of this pattern, it is crucial to ensure that the pattern forms in the context of an existing uptrend. Since this is a trend reversal candlestick pattern that reverses an uptrend into a downtrend, it is essential to have a clear and prolonged prior uptrend before the formation of this pattern so that it can effectively reverse the existing trend.
If the pattern forms with the necessary conditions—such as a significant body size of the next candle compared to the previous one, ensuring it completely engulfs the previous candle, along with an increase in volume on the bearish candle contributing to the pattern's formation—then wait for the next bearish follow-through candle to close. If this next candle closes below the previous bearish candle, then, with additional confirmation from technical indicators, taking a short position in the market would be a wise decision, resulting in a high winning rate due to multiple confirmations. In this case, the stop-loss could be placed just above the high of the previous candle where we are entering the market, and the target should be set at the next support level or according to the individual’s risk appetite.
What are the conditions for maximum accuracy of Bearish Engulfing Candlestick Pattern?
While the Bearish Engulfing Candlestick Pattern is a strong reversal signal on its own, the accuracy of this pattern can be remarkably enhanced if certain conditions are fulfilled. Understanding these conditions is crucial for traders looking to identify situations in which the reliability of this pattern in predicting market reversals is high.Here are the key conditions in which its accuracy is high:
Occurs after a Strong Uptrend: One of the primary conditions that makes traders rely on this pattern is its appearance after a sustained uptrend. When the market has been in a pronounced uptrend and the bulls have been in control for a significant period, the occurrence of this pattern signals a major shift in sentiment. The longer and steeper the uptrend, the higher the chances of a reversal based on this pattern.
High Trading Volume on the Bearish Candle: Volume is a crucial factor in determining the strength of any market indication, which also helps to cross-verify the reliability or sustainability of this pattern. An increase in volume on the bearish candle indicates that a greater number of active sellers have participated, making the chances of a continued downward move more likely.
Confirmation from Other Technical Indicators: If the formation of this pattern is supported by positive signals from other technical indicators, the reliability of this pattern increases. For instance, when a momentum indicator like the Relative Strength Index suggests that the market is in overbought territory right at the completion of this pattern, it adds another confirmation step.
Engulfing Candle's Size and Body-to-Wick Ratio: The size of the engulfing candle itself plays a significant role in determining the pattern's reliability. The larger the size of the bearish candle, the more participation from sellers, and consequently, the higher the chances of a continuation of the downward movement.
Resistance Level Confluence: Since this is a trend reversal candlestick pattern used to reverse the uptrend into a downtrend, its accuracy is maximized when it appears at key resistance levels. Resistance levels are important zones where the number of selling positions is generally high, which is why sellers at that zone oppose the price breaking through that level, leading to a reversal from those levels.
Market Context and Broader Trends: It's essential to consider the broader market context before trading based on this pattern. If the broader market context is indicating selling positions, and the asset in which the trader is going to trade is not aligning with that, then the trader should wait for additional confirmations.
The Bearish Engulfing Candlestick Pattern is one of the trusted patterns for identifying reversal areas, but under certain circumstances, its accuracy may be impacted. That is why, for more conservative trades, it is necessary to have more than one confirmation before trading this pattern.
What are the conditions Where Bearish Engulfing Candlestick Pattern may fails?
Despite the Bearish Engulfing Candlestick Pattern being a powerful reversal signal, it is not necessary that it will always be accurate. There are certain conditions in which the pattern may fail to perform as expected.Here are the conditions under which this pattern may fail:
Lack of Strong Prior Uptrend: One of the major reasons behind the failure of this pattern is its appearance in a weak or non-existent uptrend. The pattern is a bearish reversal signal, and its effectiveness is dependent on strong upward price momentum. If the pattern forms in a choppy or sideways market, it loses its predictive strength.
Low Trading Volume: Volume is key in determining the strength of any candlestick pattern, and the Bearish Engulfing pattern is no exception. Typically, higher trading volume on the bearish candle signals that more sellers have participated in the pattern, increasing its reliability. However, if the bearish candle lacks an increase in volume during the session in which it forms, it is a sign of a false signal or a temporary pause in the current trend.
Appearance in a Ranging Market: Similar to other indicators, including candlestick patterns, this pattern also fails to fulfill the requirement for reversal in a range-bound market. The range-bound market lacks proper unidirectional movement, whether it is an uptrend or downtrend. In such market conditions, the pattern may produce false signals multiple times.
Weak or Indecisive Bearish Candle: If the bearish candle is indecisive in nature, then even if it engulfs the previous candle, the chances of reversal based on this pattern are comparatively lower than with a firm candle. An indecisive candle doesn't favor either the bulls or bears, and the session in which the candle forms faces equal opposition from both sides, resulting in the formation of an indecisive candlestick.
Lack of Confirmation from Other Technical Indicators: Entering trades solely based on the bearish engulfing candlestick pattern increases the chances of receiving false signals multiple times. There are multiple directional parameters called indicators that indicate the probable movement of the market, and if they do not support the formation of this pattern, the pattern could be misleading.
Need to Know
The Bearish Engulfing Candlestick Pattern is a trend reversal candlestick pattern used to reverse the uptrend into a downtrend. The formation of this pattern reflects a psychological shift in market sentiment from bullish to bearish. This is one of the most reliable patterns, but it is not necessary that it will result in successful trades every time a trade is taken based on this pattern. There are certain conditions in which it performs best, while there are also conditions where it may fail. Understanding the basics of this pattern helps traders analyze the right entry and exit points based on the reversal it indicates. With proper assessment of the conditions required to be fulfilled in order to make effective use of this pattern, and additional confirmations such as volume increases and positive signals from indicators, traders can significantly improve the performance of this pattern.Frequntly Asked Questions
Can the Bearish Engulfing Candlestick Pattern be effective on shorter time frames?-While this pattern can be effective on shorter time frames such as 15, 10, or 5 minutes, its accuracy is impacted due to more noise in shorter time periods. In such situations, traders should seek additional confirmations.
How does the Bearish Engulfing Candlestick Pattern behave in high volatile market conditions?
-In high volatile market conditions, the pattern can perform best if the overall movement is unidirectional. However, if the volatility occurs in a range-bound market, then the formation of this pattern may not be significant.
Are there any specific technical indicators that can enhance the accuracy of this pattern?
-Yes, there are multiple indicators such as the Relative Strength Index (RSI), which shows more than 80% accuracy in trending markets. Moving averages can also help assess overall market conditions in various ways.
What should traders do if the bearish candle is not supported by enough volume increment?
-If the bearish candle is not supported by sufficient volume increment required to sustain the trend, traders should wait for multiple additional confirmations, such as signals from other indicators and price action.
