Traders use the bullish engulfing candlestick pattern to identify bullish reversals. It is an impressive two-day candlestick that features a candlestick body encompassing the previous day’s body. It is important to monitor confirmation signals in subsequent periods following a bullish engulfing pattern.
A bullish engulfing pattern occurs after a downtrend has taken place. The positioning of candlesticks relative to a price trend is a critical piece of candlestick analysis. The bullish turnaround is a signal of a trend reversal.
What Is a Bullish Engulfing Pattern?
The bullish engulfing pattern is a two-candlestick pattern consisting of a large green candle body (green indicates rising prices, but colors may differ based on your chart settings) that completely overlaps the previous time period’s body. It is a sign of a trend reversal from bearish to bullish.
This formation is more likely to portend a reversal when it follows four or more red (red indicates falling prices) candlesticks. The bullish engulfing pattern is thought to show that the bears have lost their momentum and the bulls are ready to take charge.
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The candle for the first period often features a small red body while the second time period is a candlestick with a large green body, sometimes happening on high volume. The candle for the second period also features a small gap down in price, which briefly gives confidence to the bears.
The bulls quickly grab the reins and drive prices higher intraday.
As with many candlestick patterns, it is important to know where one pattern’s position is relative to the prevailing trend. A bullish engulfing pattern should happen in a downtrend. While bullish engulfing candles can certainly happen in a sideways market or uptrend, they are not seen as definitive compared to when they take place after downward price action.
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What Does a Bullish Engulfing Pattern Tell Traders?
A bullish engulfing candlestick pattern tells traders that a price trend reversal might be happening. Placement of the bullish engulfing candle is critical: It should occur in a downtrend. The large green body demonstrates strong upward momentum — the stock (or any other asset) opens near the low of the period and rallies throughout the session to settle near the high. You can also use candlesticks over other periods such as weeks or months or even on shorter time frame charts.
In the bullish engulfing pattern the engulfing candle comes after a small red candle in which prices traded in a relatively narrow range, but still featured decidedly bearish price action. In the larger context, the bearish trend must have been in place for a significant time. This setup makes the bullish engulfing candlestick even more important as it tells the trader that a new bull market might be brewing.
While the two-day pattern is interpreted as bullish, you might still want to wait for further evidence that the trend has indeed changed. Traders often hold off on buying shares until after subsequent price action holds the bullish engulfing candle’s closing price. A bullish engulfing formation illustrates a change in sentiment from bearish to bullish.
Example of a Bullish Engulfing Pattern
An example helps display the power of a bullish engulfing candle.
Let’s say a stock fell from a high of $150 per share six months ago. A downtrend is in place. You believe the stock is a good value based on fundamental analysis but you want to wait for a bullish price trend reversal before purchasing shares.
You notice prices have been falling for five straight days, but then today’s price action had a different tone. The stock opened the prior day at $110, ranged from $107 to $111, and settled at $108. It had a red (bearish) body since the stock closed below the opening price.
Today, the stock gapped down to open at $103, dropped to $101 early, then steadily climbed on strong volume throughout the session. It notched a high of $115, then closed at $113. Since the stock closed above the opening price, the candle had a green body. It also engulfed the previous day’s body.
The bullish engulfing candle appeared at the bottom of a price trend and demonstrated an increase in buying pressure. You decide to wait for further evidence that a bottom was established and that a price uptrend is now in place. Indeed, two days after the bullish engulfing pattern, the stock held the day 2 candle’s low price.
You go long shares at $115 and place a sell stop order at $100 (below the pattern’s lowest price). You are sure to monitor support and resistance levels as the price trends higher so you can manage your position keeping risk in mind.
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How does the Bullish Engulfing Pattern Work?
The bullish engulfing candlestick pattern works by signaling a bullish trend reversal. Let’s review the benefits and drawbacks of this important candlestick formation.
Benefits of the Bullish Engulfing Pattern
There are several advantages of bullish engulfing patterns.
In general, they are easy to spot and interpret.
Offering traders defined stop loss levels is another benefit. You can also combine other technical indicators with engulfing formations to help confirm reversals.
Finally, engulfing candlestick patterns can be used on many timeframes and across different asset classes.
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Drawbacks of the Bullish Engulfing Pattern
Technical analysis does not provide an absolute prediction, so take caution when interpreting specific patterns.
Moreover, no single indicator is a sure thing – and that goes for the bullish engulfing candlestick pattern. It might be helpful to use other technical indicators to buttress your trading thesis.
Another drawback of the bullish engulfing pattern is that you might see a bullish engulfing candle on a daily chart of a stock, but then see an equally bearish candlestick pattern on its weekly chart.
It’s also risky if the engulfing candle is so big that it leaves the trader with a potentially large stop loss if the asset price reverses lower after the pattern.
Finally, there is always the risk that a false breakout or breakdown takes place, so setting reasonable exit strategies is important.
How to Trade a Bullish Engulfing Pattern
You should analyze the existing trend and look for confirmation following a bullish engulfing candlestick. This concept is important when using technical analysis to research stocks.
For example, if a bullish engulfing day happens after many weeks of downward stock price action, then a bullish reversal might be more effective at taking shape.
Monitoring volume trends is also crucial when trading the bullish engulfing pattern. Look for high volume on the day of the engulfing candle.
Finally, it might be prudent to wait for confirmation of the bullish engulfing candlestick – that means you might buy shares of a stock the day after a bullish engulfing so long as the stock price remains above the engulfing candlestick’s low price.
As additional protection against outsize losses, sell stop order is often placed below the engulfing candle’s swing low.
The Takeaway
The bullish engulfing candlestick pattern helps traders spot potential trend reversals on a chart. The pattern is defined as a two-period candlestick pattern with a green (price rising) candlestick that closes above the previous period’s opening price after beginning the current period lower than the previous period’s close. The current day’s candle body completely overlaps the prior day’s real body.
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