How to trade a bearish engulfing

A bearish engulfing is a classic candlestick formation that signals a reversal in bullish momentum in the market. This pattern is pretty hard to miss on candlestick charts. In this article, we’re going to take a closer look at the bearish engulfing, find out what it means, and how to trade safely on the basis of this indicator.

What is the bearish engulfing?

Identifying the pattern

Here is how you can identify the bearish engulfing on a typical candlestick chart:

• The engulfing – The key characteristic of this pattern is the second candle completely engulfing the body of the first candle. This means the bearish candle’s open is above the previous candle high, and its close is below the previous candle’s low. Imagine a large red candle swallowing a smaller green one whole.
  
• Pay attention to the overall trend – Bearish engulfings are most potent during established uptrends in the overall stock. Look for a series of higher highs before focusing on the engulfing.
  
• Candle size also matters – The engulfing candle shouldn’t just be covering the entire previous candle – it should be significantly larger than the previous one. That indicates stronger selling pressure and increases the reliability of the pattern.

More context

Here are some more trends you should look for before convincing yourself that the trend is changing:

• Confirmation candle – Wait for a close below the low of the engulfing candle for confirmation before entering a short position. This candlestick strengthens the bearish signal and reduces your chances of trading a false positive.
  
• Volume spike – High volume accompanying the selling pressure only provides more confirmation to your prediction.
  
• Other indicators and support – Make sure that you’re not relying just on one candle to take a short position in a stock. Try to also monitor technical indicators like moving averages and oscillators that can enhance your analysis.

How to trade a bearish engulfing

Here are some trades you can take if you’re confirmed that what you’re seeing is a reversal in the overall uptrend in a stock:

• Short it – As soon as you see a confirmation in the form of a candle closing below the engulfing candle, you can short the position. This is typically done at the open of the next candle or with a limit order placed just below the engulfing candle’s low.
  
• Protective stops – Always make sure that you’re placing a stop loss order above the high of the engulfing candle. In case this is a false positive, you have to limit your exposure.
  
• Place profit targets, don’t be greedy – If you’re right, the price will fall below your position open. Consider placing buy orders at recent support levels of the stock or use a Fibonacci retracement pattern.

Managing your risk with technical trading

It is very important for you to back your analysis up with either other technical indicators or, even better, fundamental reasons behind why you’re investing in a stock. Managing risk during technical trading is perhaps the most important thing traders must keep in mind. 

Here are some ways in which you can manage your risk in a trading position better:

• Respect the stop-loss order – This is the most crucial aspect of risk management. Always place a stop-loss order above the high of the engulfing candle. This limits your potential losses if the predicted downtrend doesn’t materialise and the price continues to rise.
  
• Don’t put all your eggs in one trade – Most professional traders have a system by which they determine how much of their capital they’re going to risk per position. 2% is common practice, where you risk no more than 2% of your trading capital on any single trade.
  
• Risk-reward ratio – Make sure that your risk reward ratio is favourable. Ideally, the amount of money you can make with a correct position should be more than the money you’re risking on that trade with stop losses.
  
• Patience and discipline – Avoid impulsive entries based solely on the engulfing pattern. Wait for confirmation before executing a short position. 

Frequently Asked Questions