Bearish Engulfing Candlestick Pattern: Technical analysts rely heavily on chart and candlestick patterns to conduct comprehensive analyses of stock prices and accurately predict their future movements. Each pattern formed in the market has a clear and justified reason behind its formation and indicates the market’s direction.

Here in this article, we shall discuss a two-candlestick pattern called the bearish engulfing candlestick pattern with its meaning, formation, indication, and how to set up a trade with this pattern formation.

Bearish Engulfing Candlestick Pattern – Definition

Bearish engulfing candlestick pattern is one of the frequently appearing patterns. This two-candlestick pattern indicates a potential shift from bullish to bearish sentiment in the market. The two candles in this pattern are as follows-

  • The first candle is bullish (green candle) which indicates the upward movement of the price.
  • The second candle is bearish (red candle) which is bigger than the previous candle. This candle also opens above the close price of the previous candle and manages to close below the open price of the previous candle. In short, the real body of the second red candle must engulf the real body of the first green candle.

This pattern can appear anywhere any trend in the market but the strength of the bearish indication is higher if this pattern is formed in an uptrend.

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Interpreting the Bearish Engulfing Candlestick Pattern

The formation of this pattern gives an early indication of a potential bearish reversal. So, if market participants observe the formation of this pattern in a stock where they hold a long position, they can consider to square off the position. 

Furthermore, as this pattern indicates a change in market sentiment, traders can also look to enter a short position based on its formation. One can also use other indicators such as RSI to get additional confirmation of a bearish reversal.

Market participants must also keep in mind that the formation of this pattern in a sideways or choppy market will reduce the probability of bearish reversal as this pattern works with a higher probability if it appears in an uptrend.

Bearish Engulfing Candlestick Pattern – Psychology

As the bearish engulfing pattern generally appears in an uptrend, the first candle is a green candle along the trend which shows that there is higher buying pressure which is pushing the price of the stock higher. Then the formation of the next big red candles shows the change in market sentiment and the sudden increase in the selling pressure. 

The formation of this pattern shows that there has been a change in the market sentiment and buyers should be more cautious while buying the stock. There might also be an increase in the number of sellers due to the change in market sentiment. 

Bearish Engulfing Candlestick Pattern – Strength

There are a few situations where the formation of this pattern would have a stronger bearish reversal indication and those situations are as follows:

  • After a significant uptrend – If this pattern is formed after a significant uptrend in the price of the stock, then there would be a higher probability of a bearish reversal. This is because the formation of this pattern would indicate a change in the sentiment and those who had taken a long position in the uptrend might start booking their profits.
  • RSI at overbought region – If the RSI is also at an overbought region at the time of formation of this pattern, then there would be a higher probability of the price going down.
  • Formation at a strong resistance zone – Resistance zones are formed when the price of the stock has reacted to a particular price more than once or the price went down after reaching that price more than once. A strong resistance zone is formed when the price has reacted to that price multiple times. So, if this pattern is formed in that zone, it shows that the price has reacted again and will probably not go above that price.

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Bearish Engulfing Candlestick Pattern – Trading Strategy

Traders must ensure that the prior trend before the formation of the bearish engulfing pattern is an uptrend. Once this pattern is formed in an uptrend, the following are the guidelines to take a trade:

  • ENTRY: When the price of the stock starts trading below the close price of the second candle of the bearish engulfing pattern, traders can enter a short position.
  • TARGET: Traders can exit the trade when the price of the security reaches the immediate support zone. Once this level is reached, one can also book partial profits in the trade and hold on to the remaining position until the next support level.
  • STOP LOSS: Traders can place the stop loss near the high price of this pattern.

Bearish Engulfing Candlestick Pattern – Example

In the above one-day chart of ICICI BANK, we can observe the formation of the bearish engulfing candlestick pattern at the top of an uptrend. As discussed, the price saw a bearish reversal and went into a downtrend after the formation of this pattern.

At the time of the formation of this pattern, a trader could have taken a short position when the price of the stock started trading below Rs. 939.85 and the stop loss was at Rs. 957.85

Bearish Engulfing Candlestick Pattern – Limitations

The bearish engulfing candlestick pattern, while a potent signal of potential reversals in uptrends, is not without its limitations. There is always the possibility of the price moving against the indication or false indications. Relying solely on the appearance of the pattern without considering additional confirmation or market context may increase the risk of trading losses.

The indication also depends on the previous market conditions and the sentiment. Despite these limitations, market participants can enhance the reliability of their trading decisions by incorporating additional confirmation signals, exercising caution, and adapting their strategies to suit the ever-changing market.

Read more: Best AI Smallcap Stocks In India

Conclusion

In this article on Bearish Engulfing Candlestick Pattern, we understood what the formation of a bearish engulfing candlestick pattern indicates, how a trader can analyze it, and how they can take a trade. In conclusion, it is necessary to remember that candlestick patterns should always be paired with other indicators and confirm the trend reversal before taking a trade.

The market is always unpredictable and may move against the indication or analysis. Hence, a trader must always place a stop loss to minimize losses in such scenarios.

Written by Praneeth Kadagi

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