Bearish Engulfing

Bearish Engulfing is a type of candlestick pattern that is widely used in technical analysis to detect the beginning of a bearish trend in the market. Traders are able to identify and use it to either exit the market or take a short position. 

The pattern appears at the end of an uptrend, making it easy to spot, with a small green candle followed by a big red candle that completely engulfs the green one. Its significance is more significant in a trending market with a clear price direction, and it is not so valuable for a choppy market with a lot of volatility. 

Bearish engulfing is a frequently used candlestick pattern that traders refer to as a bearish trend reversal indicator after an extended uptrend. It appears at the end of an uptrend within a chart and is an essential concept of technical analysis.

The bearish engulfing pattern is straightforward to spot because there is a combination of a green candle followed by a big engulfing red candle with a big body, denoting that the buying trend has reached its peak and now is the time to either sell off and exit or short the market. Here, the first candle denotes that the uptrend may continue, but the second candle gives a clear indication that a downtrend is possible. 

Traders use it to decide market positions, but they should have a stop loss in place so as to manage the risk of loss in case the market does not move as anticipated. It is always advisable to use it in combination with other indicators that identify market trends like the moving averages, trend lines, support and resistance levels, or relative strength index (RSI). This will give more clarity and reliability to this bearish pattern. 

However, the bearish engulfing candlestick also has its pros and cons, just like any other indicator. However, it is widely used for technical analysis to predict future price directions and market sentiments confidently. 

This section will explain how to identify the bearish engulfing pattern using a chart from TradingView. The chart given below clearly identifies the pattern marked within a box. For the stock of TCS, the pattern appears at the end of the uptrend that started at the end of May, and after bearish engulfing appeared almost at the end of June, there was a trend reversal downwards. 

At this point, a trader can decide to sell off their holding to book profits. They can also decide to short the stock in case they do not have the stock in their portfolio and still book profits from the fall. However, looking at other indicators like the RSI, as given in this chart, is wise. The RSI has clearly shown an overbought position since it touched the 70-level, indicating that the stock has not lost its buying momentum and is time to exit the market. Therefore, such a combination of indicators will make the trade decision more reliable. 

Source

As already stated above, it is easy to identify the signal within a chart since it shows up at the very end of a prolonged uptrend. Experienced traders use it to make trade decisions because it is a warning that the uptrend has now lost its momentum, and the market will show a down move from here.

For trading purposes, the trader first has to identify the bearish engulfing candlestick in the chart. This will help them to understand that now is the time to take a call on the next move since the trend is about to change. They will sell the stock off to avoid losses if they already have the stock in their portfolio. However, they should stop loss as per their loss-taking capacity to control the risk. 

Traders should also check the volume levels. If the volume of trade is relatively high, it is a stronger indication of trend change, which, in this case, is a signal to sell. However, some more conservative traders will prefer to wait for the next candle to appear, which they expect to be a bearish one again. This will confirm their expectation for the down move. They can also draw trendlines to check whether the pattern has crossed the support zone, which will again support the sales decision. There is also the option to go for a short position for the stock by selling it at the current price by borrowing it and then buying it back when the price falls in the future. 

Overall, the trader has to have good knowledge and make decisions after adequately studying the market movements. 

Here are some examples to understand the concept of a bearish engulfing bar.

Example #1

Mac is a long-term investor with ABC Inc. stock in his portfolio. The stock has given him a return of 50% over the last year. But then he noticed news published about the company, where its management failed to successfully pursue some critical projects it had undertaken a few years ago. This has led to some losses in their investments. After the news, Mac had been estimating a fall in stock prices, and he soon noticed a bearish engulfing pattern in the chart. He decides to sell off the stock and collects his gain. 

Example #2

The Indian stock market index Nifty 50 saw a bearish engulfing bar. Investors were hoping for a steady rise in the markets, but analysts predicted that there could be a fall due to the appearance of this pattern. Even though the index was on an uptrend overall, traders were asked to remain cautious because a slight downturn would result in a steady fall to a considerable extent. However, momentum indicators like the Moving Average Convergence Divergence (MACD) and the Relative Strength Index (RSI) also indicated a fall in the index, giving a sell signal. 

This pattern has its pros and cons, which the trader should consider while making trade-related decisions. 

Pros

• The bearish engulfing price action instantly indicates a bearish trend in the market. Traders can use it to frame strategies to make trade-related decisions. 
• This pattern signals before the actual fall so that traders can get the time to take action on their stock. This helps them to avoid losses. 
• It is easy to spot it since it appears at the end of the uptrend, usually accompanied by a considerable volume. 
• For trending markets, this pattern is very useful for identifying points of selling off or shorting the stock. 

Cons

• Bearish engulfing price action is not very beneficial if the market is very volatile and does not show any particular trend overall. Even if the pattern appears, it will not be a proper confirmation because the market may not actually go down.
• It does not show how much or to what extent the market will decrease. In other words, it does not give any idea about the momentum or strength or the down move.

This cannot be used as a standalone indicator of the starting of a bearish trend. The trader has to combine it with other indicators to get a proper confirmation. 

Even though both the above are candlestick patterns used for technical analysis, there are some differences between them, which are as follows:

• The former is a bearish pattern that indicates the market will come down, and the latter is a bullish pattern that indicates that the market will go up in the near future. 
• In the former, first, a green candle appears, and then it is followed by a big red candle that completely engulfs the first one. For the latter, the first is a red candle, which is followed by a big green candle that completely engulfs the previous red one. 
• Traders decide to sell off at the point where the former appears if they hold stock because, after this point, the prices will fall. For the latter, the case is just the opposite. 
• The former appears at the end of an uptrend, and the latter appears at the end of a downtrend.