How to Trade with a Bearish Engulfing Pattern

The bearish engulfing pattern is a two-candlestick formation that indicates a potential reversal from an uptrend to a downtrend in the market. The setup is a common tool among the trading arsenal of price action traders. This article will delve deep into the formation and explain how traders may use it to make more informed decisions.

What Is a Bearish Engulfing Pattern?

The bearish engulfing candlestick pattern is a price formation represented by two candlesticks. It shows that an uptrend may reverse soon. This pattern occurs when a large bullish candlestick is followed by a larger red bar that completely engulfs the preceding bullish candle. The bearish engulfing candle pattern suggests a potential shift in market sentiment, implying that selling pressure may outweigh buying pressure in the near future.

Traders can find this formation in various financial instruments. It may take some time to get hold of the pattern. To get a better understanding, market participants can trade on demo accounts offered by FXOpen, shifting to live trading later on.

Bearish Engulfing vs Bullish Engulfing

The bearish engulfing pattern occurs when a larger red bar completely engulfs the preceding smaller bullish candle, indicating a potential reversal from an uptrend to a downtrend. It suggests increased selling pressure and is viewed as a sell signal. On the other hand, the bullish engulfing pattern is formed when a larger bullish candle engulfs the preceding smaller red one, signalling a potential reversal from a downtrend to an uptrend. It indicates increased buying pressure and is seen as a bullish signal. Traders can analyse both setups on charts of different assets and in various timeframes for free with the TickTrader trading platform.

Identifying a Bearish Engulfing on Trading Charts

To identify a bearish engulfing on forex and other financial markets, traders may use the following steps:

Understand the components: The setup consists of two candlesticks. The first candlestick should be a bullish (upward) candle, and the second candlestick should be a larger bearish (downward) one that completely engulfs the preceding indication.
Locate the pattern: Scan your trading chart for potential formations. Look for a bullish candle followed by a larger bearish bar immediately after it.
Confirm engulfing: Ensure that the red candle fully engulfs the preceding bullish one. The high and low of the red bar should exceed the high and low of the bullish candle.
Consider the context: Evaluate the overall market context and the position of the pattern within the larger trend. The setup carries more significance after a prolonged uptrend or near a significant resistance level.
Confirm with other indicators: Utilise other technical analysis tools or indicators to confirm the formation. Look for additional signals such as overbought conditions, bearish divergence, or trendline breaks.

How to Trade the Bearish Engulfing Pattern

Trading the bearish engulfing pattern involves taking advantage of a potential reversal from an uptrend to a downtrend. Here are some steps you may want to consider to implement the pattern into your strategy easily:

Identification: Locate the pattern on your trading chart, consisting of a bullish candle followed by a larger red bar that completely engulfs the previous bullish candle's body.
Confirm the pattern: Ensure that the red bar fully engulfs the bullish candle and that the high and low of the bearish candle exceed those of the bullish candle.
Confirm with other indicators: Utilise additional technical analysis tools or indicators to strengthen the sell signal. Look for supporting evidence such as overbought conditions, bearish divergence, or trendline breaks.
Set your entry and exit points: Traders usually determine their entry points by placing a sell order below the low of the bearish engulfing candle. Also, they set stop-loss orders above the high of the bearish engulfing candle to manage risk. They usually set a target profit level based on support levels or previous price swings.
Manage risk: Implement proper risk management techniques, such as position sizing and stop-loss orders, to protect your capital and limit potential losses if the market moves against you.
Monitor the trade: Traders may track the trade as it progresses. Watch for price action confirmation and adjust your stop-loss and take-profit levels if necessary.
Review and learn: After the trade, review your decisions and outcomes. Identify areas for improvement and learn from the experience to enhance your trading skills.

Live Market Example

A trader considers a trade with one of the bearish patterns in the Netflix stock chart. They place a sell order below the second bar with a take profit at the next support and a stop-loss above the bearish candle’s high. The resistance provides additional confirmation of the price decline.

Final Thoughts

While the setup can offer valuable indications of potential trend reversals, traders don’t rely on it without additional confirmation. Complementing the formation with technical indicators and implementing effective risk management strategies to minimise potential losses is essential. Additionally, traders are cautious and are mindful of the possible occurrence of false signals, adjusting their trading strategies accordingly to enhance the likelihood of successful outcomes. When traders are confident in their strategy, they can consider opening an FXOpen account to apply their method in live trading.

FAQ

What is a bearish engulfing pattern?

It is a candlestick pattern that indicates a potential reversal in the price of an asset. It forms when a bullish candlestick is followed by a larger bearish candlestick that completely engulfs it, including its body and wicks.

Is the bearish engulfing pattern reliable?

The reliability of the formation as a signal for a trend reversal depends on various factors, including the context in which it occurs and confirmation from other indicators or patterns. While it is considered a significant sell signal, it is not infallible, and false signals can occur.

What is the success rate of the bearish engulfing pattern?

Determining the success rate of the setup in isolation is challenging since its effectiveness can vary depending on market conditions, timeframes, and other factors. The success rate of any trading pattern or signal is not fixed and can fluctuate over time.

Text source: Forex Trading Blog

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