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How to Trade the Bearish Engulfing Pattern

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Your success as a Forex trader depends on your ability to identify reversals in the market. The better you become at doing this, the closer you are to experiencing consistent profits. One pattern that can greatly assist you in doing just that is the bearish engulfing pattern.

I’ve written before that, as price action traders, our job is to find clues the market leaves behind. Those clues often come in the form of candlestick patterns such as pin bars or inside bars. The bearish engulfing candle is one more clue we can use to identify a potential top in a market.

By the end of this lesson you will know the three things that are required to make these patterns “tradable”. This will allow you to trade bearish engulfing patterns in a way that will maximize your profit and reduce your risk.

Let’s get to it…

What is a Bearish Engulfing Pattern?

A bearish engulfing pattern typically forms after an extended move up. It’s a sign of exhaustion and a signal that a market may be in the early stages of reversing.

Just as the name implies, an engulfing candle is one that completely engulfs the previous candle. In other words, the previous candle is completely contained within the engulfing candle’s range.

The following video illustrates the characteristics. I also share with you two critical rules that should be followed when trading this candlestick pattern.

 
 

The illustration below shows a bearish engulfing pattern that formed at a swing high.

bearish engulfing pattern at swing high

Notice in the illustration above, the engulfing candle’s range (high to low) completely engulfs the previous candle.

It’s okay if the body of the engulfing candle doesn’t engulf the previous candle. Only the range of the engulfing candle needs to engulf the previous candle to be considered a valid pattern.

For example, the following would also be considered a valid engulfing pattern.

bearish engulfing bar at market swing high

Notice how in this example, the engulfing candle’s range covers the previous candle, however, the body does not. This is still a valid bearish engulfing pattern.

Although the second illustration is a valid pattern, it’s far better to trade a candle where the entire body engulfs the previous and also closes below the previous candle’s low.

One last thing. These engulfing patterns are most favorable when traded on the higher time frames. Anything below the daily time frame should be ignored.

 

Trading a Bearish Engulfing Pattern

There are many different ways to trade a bearish engulfing pattern. However, the way I like to trade them is probably a bit different from what you’re used to seeing.

The strategy you’re about to learn has three requirements to be considered a valid setup.

  1. Bearish engulfing candle
  2. Swing high
  3. Broken support level

The best way (by far) that I have found to trade these patterns is to use them in combination with a break of a key level at a swing high. If you can also identify bearish price action on a retest of the broken level as new resistance, even better.

Let’s walk through an example. Below is a bearish engulfing pattern that formed at a swing high on the NZDUSD daily time frame.

NZDUSD daily forex chart

In the chart above, we have the first two requirements at work. We have a bearish engulfing candle at a swing high.

Now let’s add the key level so you can see how influential these patterns can be with the proper amount of confluence.

NZDUSD daily forex chart with bearish engulfing pattern

Now we’re starting to put this bearish engulfing pattern into context. We have two key levels at work in the chart above. Both levels are represented by highs and lows as well as several gaps. As I’ve mentioned in other lessons, these gaps often act as support and resistance.

Notice in the chart above how the bearish engulfing candle broke below one of the key levels. This gives us our third requirement, moving the pattern from a potential setup to a tradable setup.

So now that we have our three requirements, let’s move down to the 4-hour chart and see if we can find a more precise entry point.

NZDUSD 4 hour bearish pin bar at resistance

A look at the NZDUSD 4-hour chart shows a bearish pin bar rejecting the broken level.

We now have several confluence factors at work. We have a bearish engulfing pattern on the daily time frame at a swing high which broke a key level. We also have a bearish pin bar on the 4 hour chart at new resistance.

This is now a high probability trade, meaning the success rate is well above 50%. Furthermore, the setup above gave us a chance at a 3R trade (23 pip stop loss and a 68 pip profit target). That’s a 6% profit if risking 2%. Moreover, the trade took just 12 hours from start to finish.

The 50% Entry Strategy

Just as we can sell a pin bar at a 50% retracement, we can also sell a bearish engulfing pattern in the same manner. The Forex market has a habit of retracing 50% of these patterns, so why not take advantage of it?

Here is the same NZDUSD setup, only this time we’re taking a blind entry (one that does not require a price action signal) on a 50% retracement measured from the high to the low of the engulfing candle.

Using a 50% retracement to sell a bearish engulfing pattern

Note that in the NZDUSD 4-hour chart above, we’re taking a blind entry on a 50% retrace of the bearish engulfing candle that formed on the daily time frame. The high and low you see in the chart above represent the daily range of the engulfing candle.

One thing to keep in mind about blind entries is that while they can be extremely profitable, they aren’t nearly as probable as setups with price action as confirmation. This is because a blind entry has one less confluence factor at work versus a setup with confirming price action.

I don’t advocate the use of blind entries if you are just starting out. You’re far better off trading only the setups that are confirmed by price action and working your way up to trading blind entries, if you so choose.

Summary

Bearish engulfing patterns are a great way to identify a potential top in a market. It’s one more clue you can use to determine a probable outcome. The more clues you can gather about a market’s probable future direction, the closer you will be to becoming a successful Forex trader.

Here are a few things to keep in mind when trading bearish engulfing patterns:

  • A bearish engulfing candle completely engulfs the previous candle’s range (high to low)
  • A bearish engulfing pattern is a hint that a market may have formed a top
  • Any engulfing pattern below the daily time frame should be ignored
  • These patterns should only be traded at swing highs
  • The engulfing candle must break key support to be considered “tradable”
  • A 50% retracement can be drawn from the candle’s high to the low to identify an opportunity for a blind entry

In closing, just remember to look for the three requirements that form a viable setup – 1) bearish engulfing pattern, 2) swing high and 3) broken key support level. If you have those three things, you have a valid bearish engulfing setup.

Your Turn

Do you currently trade bearish engulfing patterns? If so, do you think you will change the way you trade them based on what you just read?

Leave your comments or questions below.

  • Wolfemann says:

    Hi Justin,

    How much of a break of support/resistance does the engulfing bar have to make in order for it to be valid? see my example below. I know the bar has not completed but if it holds as-is is that enough of a break?

    • Hi Wolfemann,

      Funny you should mention NZDCAD. I was just looking at this pair. I assume you meant to highlight the upper portion of today’s candle, seeing as how it’s a bullish engulfing candle? If that’s the case, today’s candle wouldn’t be a valid signal because it’s at a swing high. A bullish engulfing pattern would need to occur at a swing low to be valid.

      • Wolfemann says:

        Wow…I read the article last night and saw this setup this morning. So I was obviously confused. I asked the question and copied the chart exactly as I wanted which goes to show I need to reread the article. In any case, how much of the bar needs to pierce the s/r level whether its a bearish or bullish signal?

        • Hi Wolfemann,

          That’s a tough one to answer as it really depends on the level in question. If you’re confident that a support or resistance level is precise (the gap in the NZDUSD example above made it easy), you should be good using 10+ pips. Of course that will vary some depending on the currency pair.

          I like to see an obvious break. You want to be sure “the market” is seeing the same thing you are. If the engulfing candle closes just a few pips beyond support or resistance, you’re probably better off saving your capital for something else.

  • Angel says:

    Hi, Justin I would like to know if i can trade the engulfing pattern, on the 4 hour chart. Or is it best to trade it only on the daily chart?

  • Roy Peters says:

    There is a bearish engulfing bar forming on the Audusd at a swing high on the daily time frame as of today.

  • oswaldo rojas says:

    hola Justin Bennett que buen articulo , queria preguntar cuando puedes publicar algo así de completo sobre el fibonacci, como usarlo, todos los mejores consejos que nos puedas brindar, muchas gracias .

  • Md.Monirul Islam says:

    I believe it must be help every new traders…Thanks Justin…

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