The bullish engulfing pattern occurs on a price chart when a black/red shot candlestick is followed by the green/white or hollow candlestick the next day. Black or red candlestick indicates the opening price was higher than the closing price. Green or white or hollow candlestick indicates stocks closed higher than the opening prices. Signalling a quick turnaround in market sentiment, a bullish engulfing pattern appears as though the real body of the dark or red candle is entirely subsumed into the real body of the larger white or green or hollow candle.
This reflects that though selling pressure kept the opening prices muted. During the day, more buyers came in and pushed up the prices enough for closing prices to be higher than the previous day’s close. The real body is the wide part of the candle, which represents the range of opening and closing prices. The tail shadows of a candlestick represent the highs and lows of the day.
Chart: A bullish engulfing pattern is seen in the price chart of Bharat Electricals Limited
What is a Bullish Engulfing Pattern on a Price Chart?
1. On day 1, the prices of Bharat Electricals Limited closed lower (464.95 points) than they opened at (478.50 points), indicated by a red candle.
2. On day 2, the prices opened at 453.80, even lower than the previous opening, owing to the selling pressure. But during the day, buyers came in, and the demand pushed up the prices, eventually clocking a higher close at 491.85 points, indicated by a larger green candle. This reflects as a large green candlestick completely engulfing the red candlestick.
3. Larger the size of the second candlestick (green/hollow/white), than the smaller first candlestick, more prominent is the bullish sentiment.
4. Sometimes you may also notice the wick of the green/ white candlestick is small. The wick represents the day’s high. A short wick of the white candlestick indicates that prices closed at near day’s highs, with more buying steam left.
Significance of Bullish Engulfing Patterns
Just a downward movement in price, followed by an upward movement does not qualify for bullish engulfing. For a pattern to be termed as bullish engulfing, the prices must necessarily open lower from the previous trading session. Moreover, the prices must also gap down and close at a level higher than their previous close, irrespective of the day’s highs and lows.
1. You can usually find a bullish engulfing pattern at the bottom of a downtrend in a trending market.
2. Bullish engulfing signals a short term reversal in market sentiment which could be due to events, announcements, price correction or any other positive trigger. But to see if the reversal is a sustainable one, you need to see if the red or black candlestick in the current bullish engulfing pattern is preceded by four candlesticks that were red/black. The white or green candlestick is followed by another white or green candlestick which closes at a high above the bullish engulfing candles. That is, on day 3, prices open from the previous high closing and rise further.
3. It shows the point of transition when bulls stole the pricing game over from the bears in the market.
Trading strategies using bullish engulfing
Traders can use bullish engulfing as a buy signal in three situations:
– Day 2 Close
Traders could enter or buy when prices close higher on day 2, after having rallied to a rise from lower opening, which may indicate significant buying interest if there was a large trading volume too.
– Day after the engulfing
Some more conservative traders may choose to wait for another day after day 2, to confirm the trend reversal and sustained change in sentiment and make sure it wasn’t a blip or temporary market euphoria. Traders may choose to wait it out and see if there are signals such as stock making a new low or market gapping down further on the third day. In this bargain, they may lose potential profits but gain clarity about the price trend.
– Waiting for another signal
Along with bullish engulfing, traders look to supplement it with other signals like prices breaking out of resistance.
Conclusion: Bullish Engulfing and Bearish Engulfing pattern: Differences
A bearish engulfing pattern is the opposite of its bullish counterpart, where prices are expected to decline, and bears dominate the market sentiment. Here a green or a white candlestick is engulfed by a red or black down candlestick on the following trading day, indicating that prices closed lower not just from the opening price of the second day but also gapped down from the opening of the previous day.