How to trade the bullish engulfing pattern
July 20, 2021 10:31 AM
Bullish engulfing patterns can offer precious insight into a possible new uptrend. Let’s examine what engulfing patterns are, and how they work – including how to trade both the bullish and bearish variants.
- What is a bullish engulfing?
- How to find bullish engulfing patterns
- What is a bearish engulfing?
- How to trade engulfing patterns
What is a bullish engulfing pattern?
A bullish engulfing pattern is a candlestick formation that – according to technical traders at least –can predict an upcoming uptrend after a period of bearish sentiment. As such, it is a key bullish reversal pattern.
The bullish engulfing consists of two candles. The first is short and red, signalling continued selling in the period. The second is green, with a body that completely ‘engulfs’ the first: hence the name.
When traders spot a bullish engulfing, they take it as a sign that a downward move might be transforming into an upward one. It may be an opportunity to profit with a new buy position, or time to exit a short trade.
Learn more about how chart patterns work.
How to find bullish engulfing patterns
To find bullish engulfing patterns, look for these two candlesticks next to each other:
- A small red candle, usually at the end of a downtrend
- A much larger green candle that entirely swamps the one before
There should be a gap down from the close of the first candle to the open of the second. If there isn’t, then this isn’t an engulfing.
What’s happening here? Essentially, the bear run continues into the beginning of the second period in the pattern. The gap between the periods indicates that selling sentiment remains fairly strong.
But then, part way through the session, buyers take over. They send the market skyrocketing, well beyond the open of the red candle – and hopefully beginning a whole new bull run.
The longer the green body, the stronger the signal.
While they typically appear after downtrends, you might also see a bullish engulfing appear when a market is moving upwards. This bullish continuation pattern is taken as sign that the move still has strong momentum.
What is a bearish engulfing candle pattern?
A bearish engulfing candle pattern is the opposite of a bullish engulfing. Here, a small green candle is followed by a much larger red one which indicates a new downtrend. As with its bullish counterpart, there should be a gap between the two candlesticks, so the body of the second entirely consumes the first.
This is a bearish reversal pattern, so might be a good opportunity to open a new short position. Alternatively, if you have an open long position, now might be the time to close it.
Spotted a bearish engulfing on a market that’s already trending down? This indicates that the bear run will continue. Buyers may have won out in the small green candle, but sellers soon had the upper hand once more.
Practise trading bullish and bearish engulfing patterns
Engulfing patterns crop up fairly often on the markets, so they can be a great place to start if you’re new to technical analysis. With a demo account, you can even practise spotting and trading engulfing patterns without risking any capital – you get $10,000 virtual funds to see how your strategy would play out on live markets.
Or if you want to get started on real markets right away, open a live account here.
Engulfing pattern trading strategy
The standard trading strategy with an engulfing pattern is to open a position that takes advantage of the following move. If you’ve spotted a bullish engulfing, that means buying the market. With a bearish pattern, it means selling.
As with any pattern, though, you’ll want to confirm the trend before opening your trade. Most traders will do this by waiting. If the next candlestick continues the sentiment set out by the last one in the pattern, then they’ll trade accordingly. If it doesn’t, the pattern might have failed.
Engulfing pattern reliability
Bullish and bearish engulfing patterns are both seen as reasonably reliable indicators. However, risk management is still hugely important.
Where you place your stop depends on the market’s volatility, your risk tolerance and your strategy. You might consider placing it near the open of the first candle in the pattern, though. If the market moves back to this level, the pattern may well have failed.
Engulfing pattern examples
GBP/USD is in a long downtrend, culminating in a short red candle that opens at 1.3560 and closes at 1.3550. The next session then opens at 1.3548, but shoots up to 1.3580 by the close.
This is a bullish engulfing, because:
- The first candlestick is red, but doesn’t see much movement
- There is a gap down between the two sessions
- The second candlestick rockets up to dwarf the one before
As you’ll notice, the wicks don’t hugely matter here. It is the size of the bodies that makes a bullish engulfing.
For a bearish engulfing, on the other hand, the S&P 500 might rise 10 points in one session, then gap up a further three before the start of the next. But then a long red candlestick sees the index fall significantly more than the 13 points it gained since the open of the first period – and kickstarts a new bear market.
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