The Bearish Engulfing pattern is a strong sign of bearish reversal that is easy to spot but harder to trade. Read on for tips and tricks that can potentially help you profit from this pattern.

How to trade the Bearish Engulfing Pattern

The Bearish Engulfing Pattern: a powerful sign of bearish reversal whose very name speaks of destruction. This pattern is one of the more easy to spot candle patterns but one tricky to trade because it is a contrary indication. When the market is trending higher, the thing to do is trade bullish signals, and a bearish engulfing pattern is not a bullish signal.

What exactly is a bearish engulfing pattern and how do you spot one? First, this pattern forms when prices are in an uptrend and trading at or testing a high. The first candle will be white and may have upper or lower shadows. The second candle will form at or above the close of the first candle, it will be black and close below the first candles lowest point so it fully covers the first candle. Spotting one is easy: if prices are trading at a peak, an all time high or at a resistance point and a black candle forms that meets the criteria, you have an engulfing pattern.

What the engulfing pattern means is a change in trend. No longer are the bulls in charge, the bears have stepped in and now putting pressure on prices. What it doesn’t mean is an immediate reversal in prices, or even that prices will fall significantly. A change in trend could simply mean prices have entered a trading range which is why looking for secondary indications and waiting for confirmation in the candles before changing tactics. If you are long, this may be a good time to take profits.

Secondary indications are the signals you find in other indicators. In this case, I am using MACD for momentum and stochastic for trend and market health. If you notice, both the indicators in the chart below are diverging from the new high. Divergence is an indication of market weakness, slowing momentum and potential for reversal. It is a confirmation of the Bearish Engulfing Pattern, increasing the likelihood the trend is changing.

On this chart we can see that the day following the Engulfing Pattern is an up day and that may negate the pattern. This is why waiting for a second signal is usually the best idea. You may be able to profit by entering on the close of the first candle, but there is no guarantee prices won’t retrace to retest resistance as they are here. In this case, prices are finding resistance at the bottom of the uptrend line, yet another confirmation the uptrend is over and price direction is changing.

Taking this chart into consideration, selling the USD/INR when price is at or above 67.25 is good trade provided there has not been an economic event (data, central bank) to support the move. Targets for exit begin at the bottom of the Engulfing Pattern near 67.00 with a chance of moving down to 66.50 in the near term. Because there is no down trend established bearish, trades should be cautious ones that use support targets for profit taking.