Bullish Engulfing Pattern

Ever wondered how professional traders predict trend reversals with high accuracy? Most of them know numerous patterns. One such candlestick pattern is the Bullish Engulfing pattern. The Bullish Engulfing pattern is all about when the trend reverses from bearish to bullish, and buyers take control.

In this blog, we will discuss the Bullish Engulfing candlestick pattern, its characteristics, trading setup, advantages, and disadvantages with an example.

What is the Bullish Engulfing Pattern?

A Bullish Engulfing pattern is a bullish reversal pattern where buyers take charge and indicate a change of trend from bearish to bullish because it appears after a downtrend. The pattern consists of two candles, and the bearish candle is smaller than the following bullish candle. It is a key reversal pattern and can be observed in candlestick charts. Traders use this pattern to create long positions or exit short positions.

Characteristics of the Bullish Engulfing Pattern 

The Bullish Engulfing pattern is a candlestick pattern used to identify a potential reversal from a downtrend to an uptrend. It unfolds as per the following phases:

• Two Candle Pattern: This is a two-candle chart pattern in which the first candle is bearish, and the second candle is a big bullish candle. The bearish candle is smaller than the bullish candle.
• Engulfing: The second bullish candle completely engulfs the body of the first bearish candle.
• Formation: It generally forms after a long downtrend and indicates a possible trend reversal. 
• Psychology: The large bullish candle shows that the buyers are in control now, and the trend will change.
• Other Considerations: Always wait for a further price increase after the bullish engulfing candle for better accuracy. Once the next candle gives a breakout above the high of the engulfing candle with increased volume, it can be seen as a confirmation signal for trend reversal, and traders can create long positions.

This pattern helps traders recognize when a bearish trend may be coming to an end, offering opportunities to exit short positions or to enter long positions. 

Trading Setup

The Bullish Engulfing pattern can be effectively used by following the below trading setup:

• Entry Point: The entry point should be when the price gives a breakout above the high of the bullish engulfing candle. Look for the increase in volume to get a confirmation and then create a long position.
• Stop Loss: A stop-loss should be placed just below the low of the engulfing candle to manage risks and reduce losses if the pattern gives a false breakout.
• Target: The trader can determine target levels by using resistance levels, Fibonacci levels, or customized risk and reward ratios.

Advantages of Bullish Engulfing Pattern

The advantages of the Bullish Engulfing pattern are:

• It works in any market, such as equity, currency, or commodity markets.
• The pattern can be used on any time frame, but a bigger time frame suggests a strong trend reversal is expected.
• It is easy to identify. 
• The pattern is a reliable reversal signal indicator.
• Traders can capture large moves using this pattern.
• The pattern provides a logical understanding of price action and a complete trading setup.
• The pattern can be combined with other indicators to get confirmation.
• This pattern gives quite accurate results if a breakout above the high of the bullish engulfing candle occurs with strong volumes.

Limitations of Bullish Engulfing Pattern

The limitations of the Bullish Engulfing pattern are:

• The pattern can give false signals in a sideways market.
• The pattern interpretation can sometimes be subjective as there can be minor changes in candle size.
• The pattern is not effective in a very strong bearish trend.
• The pattern could give a false breakout and fail like any other pattern, resulting in losses.
• This pattern could be affected by various market factors, such as volatility, news, policy change, political instability, etc.
• The pattern’s reversal signal requires confirmation from other indicators for better accuracy.

Example: Bullish Engulfing Pattern for DLF

The above image shows the price chart of DLF on a weekly time frame. In the second week of March 2022, the stock price made a Bullish Engulfing pattern as the bullish candle completely engulfed the previous week’s high and low. The stock price increased from INR 353 to INR 401 in the following weeks. The target zone can be marked at the Fibonacci Levels or the nearest major resistance level. A stop-loss can be placed just below the low of the bullish engulfing candlestick and trail stop-loss as the stock price increases.

Conclusion

The Bullish Engulfing candlestick pattern is popular among both investors and traders due to its accuracy. It signals a potential trend reversal in the security’s price from bearish to bullish. Confirmations such as volume spikes can be used to identify strong breakout signals. The pattern also has some limitations, such as false signals in sideways markets and ineffectiveness in short-term time frames. Hence, it is important to understand the pattern’s characteristics, trade setup, and risk management strategies before trading. It is advised to consult a financial advisor before investing.

Frequently Asked Questions (FAQs)