How does Bullish Engulfing Candlestick Pattern Formed?
The Bullish Engulfing candlestick pattern forms over two trading sessions. First, a bearish (red) candle appears, indicating continued selling pressure. The following day, a bullish (green) candle opens lower but closes significantly higher, completely covering or “engulfing” the body of the previous red candle. This shift signals that buyers have overtaken sellers in strength. The larger the green candle in comparison to the red one, the stronger the bullish signal. The pattern is considered more significant when it forms near a support level or after a prolonged downtrend.
When do Bullish Engulfing Candlestick Patterns occur?
Bullish Engulfing patterns typically appear at the end of a downtrend or during a pullback within a larger uptrend. They act as a sign of potential reversal, suggesting that selling pressure may be weakening and buyers are beginning to take control. Candlestick Chart Patterns are more impactful when they form near key support zones or after an extended period of bearish activity. When combined with other indicators such as high trading volume or oversold conditions, the pattern offers a stronger signal that an upward price movement may follow.
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
The Bullish Engulfing pattern plays a crucial role in technical analysis by signalling a possible reversal in a downtrend. It reflects a shift in momentum where buyers overpower sellers, often leading to an upward price movement. This makes it valuable for traders looking to time their entry points.
Key reasons why it matters:
- Trend reversal indicator: Often marks the end of a downtrend and the beginning of bullish momentum.
- Market sentiment shift: Shows a transition from seller dominance to buyer strength.
- Entry signal: Helps traders identify potential buying opportunities at lower price levels.
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.
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