In this article:
- What is a candlestick?
- What is a reversal pattern?
- What is a bullish engulfing pattern?
- Example of a bullish engulfing pattern
- What is a bearish engulfing pattern?
- Example of a bearish engulfing pattern
- The concept of candlestick addition
What is a Candlestick?Just as we have a line chart, area chart, bar chart, a candlestick is also a type of chart. But, this chart has some special qualities and that’s the reason it is preferred by most traders. So the special quality of a candlestick is that it displays the open, high, low and close prices of a stock. It is named candlestick because it resembles to a real candle with a wick.So, a candlestick consists of two major things.
- The body of the candle
- The wick of the candle
But again you might wonder, what is a reversal pattern?A reversal pattern indicates that a particular trend is coming to an end. When a reversal pattern appears during an uptrend, it indicates that there is a bearish reversal and vice-versa.Today we are going to discuss two types of reversal patterns.
- A bullish engulfing pattern
- A bearish engulfing pattern
Bullish Engulfing PatternFirst, let’s discuss a bullish engulfing pattern. Take a look at the pair of candlesticks below and try to understand what it represents?Here the first candle is a bearish candle. The second candle is a bullish candle. But did you notice? The second candle covers the first candle. This is a perfect example of a bullish engulfing candle. This pattern is formed in a downtrend. The first candle is always a bearish (red) candle. On the next day a bullish candle (green candle) is formed which entirely engulfs the first candle.Such a formation indicates that the bulls have taken over the bears and the trend will possibly turn bullish.But, should you buy a stock as soon as you see a bullish engulfing pattern?The answer is a big no.Even in the previous article on candlestick charts, we had mentioned that you must never place a trade until you get a confirmation.So now the question arises, in a bullish engulfing pattern, when do you get a confirmation?If in the next two to three days, the stock trades about the big bullish candle then we can say that there has been a reversal.This is what the chart would look like.If you notice in the above image I have drawn a dotted line above and below the body of the bearish candle and not the wick? So, if the bullish candle is not able to cover the wick of the bearish candle? Will we still call it a bullish engulfing pattern?In a perfect world, the bullish candle should cover the wick. But, if we take a look at the majority of the charts where engulfing patterns are formed, the conclusion we get is that engulfing the wick is not that important. If the body of the candle is engulfed, it is a valid bullish engulfing pattern.So, in the real world, the bullish engulfing pattern would be similar to this.Here, the wick of the bearish candle is not entirely engulfed by the bullish candle but still, we would classify this as a bullish engulfing pattern.Now, there are few variations in the bullish engulfing pattern. Sometimes, you might also come across a situation where one candle engulfs two or more previous candles. This is also a type of bullish engulfing pattern.Take a look at the illustration below.
Variation one:In the above image, the green bullish candle completely engulfs the body of the previous three candles.
Variation two:Opposite to the previous illustration, here one bearish candle is engulfed by following three bullish candles. This is another type of bullish engulfing pattern.
Variation three:In this image, a small bearish candle is there in the middle of a big bearish and big bullish candle. The small bearish candle doesn’t matter if it appears in the middle of the body of the previous bearish candle. If the bullish candle is able to engulf the body of the bearish candles formed, it is a valid bullish engulfing pattern.
Interpretation of a Bullish Engulfing CandleTo form an engulfing pattern there has to be a prior ongoing trend. In this case, the trend should be a downtrend. The price of the share keeps moving down until we see a bullish candle (green candle) which engulfs the previous bearish candle (red candle).The bullish engulfing candle is formed when the share opens lower than the previous trading session and closes higher than the previous close.So, before a bullish engulfing pattern is formed, the traders anticipate that the price of a share is going to fall and they sell the shares. With low buying pressure, we see a formation of multiple bearish candles. When the share is close to the support levels, traders feel that the share is undervalued and is the right opportunity to buy. With high buying pressure, the share price bounces back which engulfs the previous candle.So, the bullish engulfing pattern indicates that the market participants are no longer in favour of the bearish trend and the bulls are back in full power.
Real-life Examples of Bullish Engulfing Pattern.
Bullish engulfing pattern formed in Mahindra and Mahindra Financial Services LtdThe stock was in a downtrend from 15th February 2021 to 20th August 2021. The candle formed on 21st August 2021 with an open of Rs. 139.55 and a close of Rs. 145.45 was engulfed by a bullish candle on 22nd August 2021 with an open of Rs. 146.40 and a close of Rs. 139.45.The stock was trading above the engulfing pattern for the next two to three days which was a confirmation that there has been a reversal. Since then the stock has been in an up move of 48.98%.The stock was in a downtrend from Rs. 601.95 to Rs. 462.95. On 28th October 2021, we saw a bearish candle which was engulfed by a bullish candle on 29th October 2021. Later, we saw a reversal in the stock which lasted for a short span.In the above chart we have also found an example of a bearish engulfing pattern. Let’s now explore a bit about it too.