Key takeaways
- A bullish engulfing pattern is a two-day candlestick formation that may indicate a potential reversal from a downtrend to an uptrend.
- It occurs when a small black (bearish) candlestick is followed by a larger white (bullish) candlestick that completely engulfs the previous day's body.
- This pattern gains more significance when it appears after four or more consecutive bearish candlesticks, suggesting that selling pressure might be easing.
- For better analysis, investors should consider not just the two candles forming the pattern, but also the preceding market trend and momentum.
- It is most effective when supported by additional technical indicators or patterns confirming a possible reversal.
How to identify a bullish engulfing candlestick pattern?
A Bullish Engulfing Pattern is a technical analysis indicator that suggests a potential reversal of a downtrend. It is characterized by two consecutive candlesticks:
- A small bearish candle: This represents a period of selling pressure.
- A larger bullish candle: This candle must completely engulf the bearish candle, indicating a stronger buying force that has overcome the previous selling pressure.
Steps to identify a bullish engulfing pattern
- Identify a downtrend: Look for a series of lower highs and lower lows in the price chart.
- Locate a small bearish candle: This candle should be at the bottom of the downtrend.
- Look for a larger bullish candle: This candle should follow the bearish candle.
- Verify engulfment: The bullish candle's body must completely enclose the bearish candle's body.
- Check price range: The bullish candle's high should be higher than the bearish candle's high, and its low should be lower than the bearish candle's low.
- Consider context: The pattern is more significant if it occurs after a significant price decline.
- Confirm with other indicators: Use additional technical analysis tools, such as volume and momentum, to strengthen the signal.
What does a bullish engulfing pattern tell you?
In the bullish engulfing candlestick indicator, the second candle covers the first entirely. Since the second candle represents a bullish session, here is what the pattern tells you about the price movement on day 2.
- The price opened lower on day 2 than the closing price on day 1.
- Then, by the end of the second day, the price shot up and closed well above the opening price on day 1.
This is why the real body of the second candle engulfs the body of the first one. It indicates that the sellers dominated the market on the first day, leading to a bearish candle. Then, when the markets opened on the second day, the sellers continued to push the market down, leading to a lower opening than the previous day’s close.
However, the buyers or the bulls gain control over the second trading session and drive the price steeply upward, so it closes much higher than the previous day’s opening. This price action indicates a switch in control from the sellers to the buyers. Hence, the bullish engulfing pattern is considered a possible indicator of a bullish reversal.
Bullish engulfing pattern vs. Bearish engulfing pattern
The bullish and bearish engulfing patterns are mirror images of each other. While the bullish version signals the potential beginning of an upward trend following a decline, the bearish engulfing pattern appears after an upward price movement and suggests a possible reversal to the downside. In a bearish engulfing pattern, the first candlestick is a smaller bullish candle, followed by a larger bearish candle that fully encompasses the previous one. This signals that sellers have taken control, potentially leading to further price drops.
Importance of the bullish engulfing candlestick pattern
A bullish engulfing pattern is characterised by the following conditions:
- Price movement: A downward price movement is followed by a significant upward price movement.
- Open price: The current trading session's open price must be lower than the previous session's close.
- Close price: Regardless of intraday price fluctuations, the current session's close price must be higher than the previous session's close.
This pattern often appears at the bottom of a downtrend in a trending market.
Interpretation: A bullish engulfing pattern signals a potential short-term reversal in market sentiment, often triggered by news events, announcements, price corrections, or other positive factors.
Confirmation: To enhance the reliability of the reversal signal, consider the following:
- Preceding candles: If the bullish engulfing pattern is preceded by a series of consecutive downward candles, it strengthens the reversal indication.
- Subsequent candles: A subsequent upward candle that closes above the high of the bullish engulfing pattern further confirms the reversal.
Significance: The bullish engulfing pattern marks a point where buyers have gained control over the market, potentially indicating a shift in momentum.
How do you trade a bullish engulfing pattern
Noticing a bullish engulfing candlestick on a chart is not enough to chart out a buying strategy. You need to confirm the potential reversal with other signals that typically accompany a switch to an uptrend. Here are the confirmation signals to look for when you want to trade a bullish engulfing candle.
- The candles before day 1: To confirm a reversal when a bullish engulfing candlestick appears, you need to check the candles that come before the first trading session in the pattern. Ideally, there must be at least four red/bearish candles before the pattern to establish a prevailing downtrend.
- The candle after day 2: Once the green candle appears in the bullish engulfing pattern, look for confirmation in the next session. A bullish candle could indicate that the buyers have taken control of the market and set the stage for a confirmed reversal from a downtrend to an uptrend.
- The trading volume: The trading volume may be moderate on day 1, but in the bullish trading session on day 2, you should ideally notice rising volume as the price goes up. This indicates growing interest among buyers along with fading interest among sellers — which is just the confirmation you need for a bullish reversal.
Example of a bullish engulfing pattern
Let’s take a fictional scenario involving the shares of "IndTech Solutions Ltd.", an IT firm. After experiencing a steady downtrend for over a week, the stock closed at Rs. 485 on 5th July. The next trading day, 6th July, began with some hesitation, but buyers stepped in strongly. The stock opened at Rs. 480 and rallied to close the day at Rs. 495, forming a large bullish candlestick that entirely engulfed the previous day's smaller bearish body. This bullish engulfing pattern suggested that buying momentum was building, potentially marking the beginning of a new upward trend.
Limitations of using engulfing patterns
A bullish engulfing candlestick pattern has a few limitations that you should be mindful of before you enter a trade. Firstly, if the pattern occurs after a vague or choppy downtrend, it may not be a powerful indicator of a reversal. Also, if the second candle in the pattern is significantly large, it indicates a huge price jump on day 2. This means you may have to set a huge stop-loss if you enter the market at this point — leading to a skewed risk-reward ratio.
Conclusion
The presence of a bullish engulfing candle could indicate a potential reversal from a downtrend to an uptrend. If you notice this pattern in the broad market or in a stock you are tracking, make sure you check for other confirmation signals like increased trading volume in the second session, subsequent bullish candles, and a breakout from a previous resistance level. This way, you can make a more informed decision.
Related articles
