The bearish engulfing signal is important to learn since it is one of the major candlestick patterns. This signal visually illustrates that there has been a dramatic change in investor sentiment. More specifically it conveys an extremely high probability that the buying is over and there may be an opportunity for establishing a good short position.
The bearish engulfing pattern is a major reversal pattern comprised of two opposite colored bodies. It is formed after an up-trend and it opens higher than the previous day’s close and closes lower than the previous day’s open. Therefore the black or red candle completely engulfs the previous day’s white or green candle. Engulfing can include either the open or the close and it must be equal to the open or close of the previous day, but not both.
Criteria for bearish engulfing pattern
- The body of the second day completely engulfs the body of the first day. Shadows are not a consideration.
- Prices have been in a definable uptrend even if it has been short term.
- The body of the second candle is opposite color of the first candle with the first candle the color of the previous trend. The exception to this rule is when the engulfed body is a “doji” or an extremely small body.
Signal Enhancements for bearish engulfing pattern
- A large body engulfing a small body. The previous day was showing the trend was running out of steam. The large body shows that the new direction has started with good force.
- When the engulfing pattern occurs after a fast spike up there will be less supply of stock to slow down the reversal move. A fast move makes a stock price over-extended and increases the potential for profit taking and a meaningful pullback.
- Large volume on the engulfing day increases the chances that a blow-off day has occurred.
- The engulfing body engulfing more than one previous body demonstrates power in the reversal.
- If the engulfing body engulfs the body and the shadows of the previous day the reversal has a greater probability of working.
- The greater the open gaps up from the previous close the greater the probability of a strong reversal.
After an uptrend has been in effect the price opens higher than where it closed the previous day. Before the end of the day the sellers have taken over and moved the price below where it opened the day before. The emotional psychology of the trend has now been reversed.
Most stock market data is numeric and requires evaluation of complicated formulas but candlestick patterns provide the very same information in a graphic form. Candlesticks were developed specifically to add more information to chart analysis and are very basic visual analytical tools that provide a very clear representation of what is occurring with investor sentiment. Whether day trading, swing trading, or long-term investing, the major signals work effectively in any time frame.
Be sure that you also read about the Bullish Engulfing signal.