The bearish engulfing pattern: another great forex trend reversal and continuation pattern…
Bearish Engulfing Candlestick
SIGNAL: Bearish, Strong
The bearish engulfing pattern consists of two individual forex candles. Since both the signal and the confirmation are contained in the second candle, I will refer to that candle here as the confirmation candle:
Setup Candle: The first candle is bullish and preferably occurs at the end of a significant push upwards in price.
Confirmation Candle: The second candle is a bearish candle whose body is larger than that of the setup candle, effectively engulfing it. The closing price of the confirmation candle is lower than the low of the setup candle.
PSYCHOLOGY AND FUNDAMENTALS
Bearish engulfing patterns usually set up at the top of a move up in price, whether that move is part of a long-term trend or a short term retracement. The two scenarios are:
- When it occurs at the end of a long run up in price it signals the exhaustion of the supply of buyers and the drawing in to the market of sellers. At this stage sellers will be more inclined to enter the market on the offer of a currency pair at comparatively expensive levels. In one concerted push they defeat the buyers, exceeding the extent of the effort of the bulls during the previous candle and completely reversing price direction.
- The bearish engulfing pattern can also occur in an downtrend when price temporarily retraces, preferably to a resistance level. This temporary move upwards may be due to sellers taking profit, buyers moving into the market at the relatively deflated prices, or just normal cyclical market exhaustion as the sell orders thin out. Hence price moves up to a level where sellers are ready to once more start moving into the market, pushing price down again.
TRADE ENTRY & STOP LOSS
You can enter either a Buy Stop order 2 to 5 pips in front of the lowest price the confirmation candle reached, or if you are confident enough of the move down you can enter aggressively with an At Market order. Either way, your Stop should go 2 to 5 pips behind the high of the setup candle. This is a rough guide only: in volatile markets you may choose to extend the stop further out, and for much higher time frame charts such as the daily you may set stops 5 to 20 or even more pips behind the high of the setup candle.
The larger the bearish candle that confirms the pattern, the more likely price will move down. However, if the confirmation candle is extremely long you may have trouble getting in with a reasonable reward to risk ratio.
For example, you may have to set a stop loss of 50 pips to set the stop comfortably behind the high of the setup candle. If there is a strong area of support only 20 pips below current price action, you may consider this to be a low probability trade and pass on the opportunity.
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