Technical analysis refers to the analysis of the movement of prices of an asset, usually stock, through price and volume patterns. It is done to identify trading opportunities. In simpler words, it helps to determine which stocks can rise or fall in the future. This analysis also helps in deciding which stocks to buy or sell. The main components of technical analysis are – technical charts, candlestick patterns, trading strategies, and indicators.
Candlestick patterns depict useful price movements which provide information about the future price of the asset, usually stock. There are two types of candlestick patterns – single candlestick patterns and multiple candlestick patterns. In this blog post, a very important and interesting type of multiple candlestick pattern – The Bullish Engulfing will be discussed by us in depth.
The Bullish Engulfing Candlestick pattern is a type of bullish candlestick pattern. It is formed at the end of a downtrend and gives a warning alert that the bearish trend is going to reverse. It signals the beginning of an upward movement of prices. It is formed of 2 candlesticks – A bearish candle, followed by a big bullish candle which completely engulfs the body of the previous bearish (red) candle.
Bullish Engulfing Candlestick Formation
What was just discussed above was which type of candle formations are necessary for the candlestick pattern to qualify as a bullish engulfing candlestick pattern? But, now let’s understand how and why these single candles are formed and what is its significance. Understanding the reason behind its formation will help to understand its uses and limitations in trading.
The asset is in a downtrend and the prices continue to fall. Hence, in the first candle of formation of a bullish engulfing candlestick pattern, the share price opens low and falls further to make a new low. This denotes a bearish pressure in the market. Then, on the second day of the formation of the pattern, the second candle opens near the close of the first candle.
Then, a reversal happens and sudden buying pressure in the markets arrives. Bullish investors take over and buy, even more, leading to the formation of a very big green candle that totally engulfs the body of the previous red candle. The sellers are not able to keep up with the buying pressure, and hence the buyers overshadow the sellers leading to nervousness. Hence, after the formation of a bullish engulfing candlestick pattern, the market is expected to rise for the next few days.
Also, note that the second candle must totally engulf the body of the first candle for it to be qualified as a bullish engulfing candlestick pattern. Also, the first candle should necessarily be a red candle making a new low than the previous day’s low.
Trading with Bullish Engulfing Candlestick pattern
It is advisable to give more conviction to the analysis by combining it with some technical indicators like support and resistance. This will help keep the odds in one’s favor.
This is a price chart of HDFC Bank Ltd. As one can see, a bullish engulfing pattern is formed in the highlighted area. The second candle fully engulfs the body of the first red candle. One
can buy the share near the closing on the second day, once it is confirmed that the green candle is fully engulfing the red candle. Also, if the bullish engulfing candlestick pattern is formed with a support level on it, then the pattern is more robust.
The probability of working out of the pattern is higher. As, in this case, the bullish engulfing is formed at a support level of Rs. 1,426. From, there the price takes support and resists moving downwards. It is indicated by the formation of a bullish engulfing pattern on the support. Then, one must sell when the target is hit or the stop loss is breached. One can sell as the price nears the resistance and hits the target. One can also opt to trail the stop loss to lock in profits.
Uses of Bullish Engulfing Candlestick pattern
A bullish engulfing often triggers a reversal in trend as more buyers enter the market to drive prices up further. A bullish engulfing candlestick pattern can be effectively used to identify short or long-bullish swings. It is an effective strategy for swing trading.
Cautions while trading with Bullish Engulfing Candlestick pattern
- Volume – It is advisable to check the volume before entering a trade using a bullish engulfing candlestick pattern. If the volume is very high, then it gives an even stronger confirmation to enter the trade.
- Use with indicator and price action – The patterns formed are sometimes not completely accurate. Hence, it is important to combine the pattern with technical tools like support resistance, etc. to get a stronger confirmation.
Entry and Exit points for a trader
The entry point depends on the risk trading capacity of a trader:
- Risk-taker – A risk-taker would enter the trade on the last day of pattern formation, that is at 3:20 p.m. before the end of the trading day (on daily charts), or even the next day morning at 9 AM. If all the pattern rules are validated, then the trader would like to cap those extra profits he might make.
- Risk-averse – A risk-averse trader would enter the trade on the day after the formation of the bullish engulfing pattern after he/she gets confirmation on the following day. If on the day after the bullish engulfing pattern is formed, a red candle is formed, then a risk-averse trader ignores the trade.
In a bullish engulfing candlestick pattern, the stop-loss is the lowest point of the pattern. This means that whichever is the lowest price point between the red candle and the subsequent green candle is the stop-loss.
Are you interested in taking a trade using bullish engulfing candlestick patterns or any other candlestick patterns? Like there is a bullish engulfing candlestick pattern, there is also a bearish engulfing pattern which is a type of bearish candlestick pattern. It is formed at the top of an uptrend and gives a warning alert that the bullish trend might reverse. It signals the beginning of a downward movement of prices.
For more information about different types of candlestick patterns and how to use them, keep following the Goela School of Finance.