A Trader’s Guide to the Bullish Engulfing Candlestick Pattern

What is a Bullish Engulfing Candlestick? 

A bullish engulfing candlestick is a powerful two-candle reversal pattern. It forms when a smaller bearish candlestick (downward) is immediately followed by a larger bullish candlestick (upward), which completely overlaps or engulfs the previous candle’s body.

This pattern signifies that buyers have overwhelmed sellers, potentially reversing the bearish trend into a bullish trend.

Examples of Bullish Engulfing Candlestick Patterns

Bullish engulfing patterns on the higher timeframes, such as the 4H or higher, tend to offer more reliable signals, resulting in less false signals or fake outs. If the bullish engulfing pattern creates a large wick which sweeps below the first candle’s low, the reliability of the signal is further enhanced as it signifies strong buyer interest at lower prices. For example, as you see on the Dow Jones and Gold Chart above.

Weaker bullish engulfing candles may appear more frequently on lower time frames with these characteristics

• Less expansive
• Do not create new lows (Sweeps)
• Are in a local downtrend, lowering the likelihood of a significant rally

Remember, not all bullish engulfing candles are created equally. Some are more likely to play out, others are not. Thus, it’s important to pay attention to support and resistances, the broader trend, and the size and timeframe of the pattern to trade it effectively.

Case Study: S&P 500 Bullish Engulfing Pattern

On October 13, 2022, the S&P 500 exhibited a classic bullish engulfing pattern. This pattern featured a minimal upper wick, indicating robust buying pressure throughout the session. Additionally, the price opened significantly lower than its previous candle, creating a candlestick that truly engulfs the prior candle.

This effectively marked the lowest point in the market, as prices have not returned to these levels since, underscoring the significance of using bullish engulfing patterns to identify potential rallies and reversals.

How Do You Trade Bullish Engulfing Candlesticks? 

A bullish engulfing candlestick pattern can be traded in many ways. Generally, it’s more effective to use multiple confluences, or ‘aligning evidence’ to support your bullish engulfing signal before entering a long position. However, there’s also a sweet spot – add too many factors to look for, and you’ll be confused while trading, or even struggle to find a valid entry.

Here are three fantastic methods to begin trading this pattern.

Method One: Buy on the Pullback in an Uptrend

Bullish engulfing candles can mark the bottom of downtrends and indicate reversals, but these can sometimes be false signals. To lower the odds of a false signal, look for bullish engulfing candles during broader uptrends.

For example, observe this EUR/USD chart in the 1H timeframe from July 4 to July 16, 2024. As you see, EUR/USD is in a broader uptrend, and multiple, consecutive bullish engulfing patterns have resulted in rallies.

“The trend is your friend, until the end.”

This is a simple, yet effective saying in trading that rings true. When you trade with the trend, the odds of your success are magnified.

To trade this strategy, observe an uptrend in the markets, where the price is consistently forming higher highs and higher lows. Then, when there is a pullback (price decrease) in the market, start looking for a bullish engulfing pattern.

On the confirmed formation of the pattern, we want to:

• Open a long position on the candle close.
• Set our stop loss below the pattern, and take profit to 2 times the risk.

With this strategy, we’ll aim to trade with the trend until it fails us. Like the quote says, the trend is your friend, until the end. This means that all good things must eventually come to an end, and the price will at some point break its uptrend and retrace even further – but that’s okay!

We would have won multiple trades by then and significantly offset the loss from a losing trade. For example:

Trading Strategy Summary:

Entry Point: Enter long on a pullback when a bullish engulfing candle forms during a confirmed uptrend.

Stop-Loss: Place a stop-loss just below the low of the engulfing candle.

Profit Target: Aim for a 1:2 risk-to-reward ratio or target a previous resistance level.

Method Two: Using Exponential Moving Averages for Fixed Risk-to-Rewards

Another effective way to trade the bullish engulfing candlestick pattern is by incorporating Exponential Moving Averages (EMAs) to enhance your trading strategy. EMAs are commonly used to identify trends and can act as dynamic support and resistance levels, making them a powerful tool for identifying high-probability trades.

In this strategy, we use two key EMAs: the 20 EMA (orange line) and the 50 EMA (red line). When the 20 EMA is above the 50 EMA, it signals a bullish bias, making it a prime time to look for bullish engulfing patterns. 

For this method, once you spot a bullish engulfing pattern enveloping either the 20 EMA or the 50 EMA while the 20 EMA is above the 50 EMA, you can enter a long trade with a fixed risk-to-reward ratio. A 1:2 RR is typically a good starting point, though a 1:3 RR can be even more effective in stronger trends.

This strategy works particularly well when the price is forming new highs. In these conditions, predicting how far the price will go can be difficult, so using a fixed RR ensures that you lock in profits at a predefined level, protecting you from potential reversals.

Trading Strategy Summary:

Entry Point: Enter long when a bullish engulfing candle forms near or bounces off the 20 EMA or 50 EMA, with the 20 EMA above the 50 EMA. Set your entry limits on the close of the bullish engulfing candle. 

Stop-Loss: Place a stop-loss just below the low of the bullish engulfing candle.

Profit Target: Set a fixed 1:2 or 1:3 risk-to-reward ratio for your take-profit target. In this example, the target is a 1:2RR.

Method Three: Buy at Support, Exit at Resistance

The third way to trade a bullish engulfing pattern is to wait for it to form at a support level. This will provide extra reason for your trade to move to the upside, as buyers are expected to exhibit more interest at support levels.

Additionally, marking out key resistances can help you identify where is best to take profit, potentially resulting in higher RR (larger than 1:2). In our example, we achieved a 3.7RR win by using this method. This style of trading, especially in the daily timeframe, can take much longer to play out — but is worth the wait.

If you like swing trading, this sort of trade is your bread and butter!

Trading Strategy Summary:

Entry Point: Place limit orders at the close of the bullish engulfing candle after reconfirming support.

Stop-Loss: Set a stop-loss just below the low of the bullish engulfing candle.

Profit Target: Target a key resistance level, such as a previous swing high, for larger gains.

Method Four: Fibonacci and Bollinger Bands® Strategy

This strategy requires an understanding of more advanced tools such as the Fibonacci Retracement, and the Bollinger Bands.

The first tool at our disposal is the Fibonacci retracement tool. On many charting platforms, this tool is represented by a [☰] symbol. We’ll be using TradingView to illustrate our example.

Traditionally used to see retracement levels such as the 0.618, a less-known (and slightly unconventional) tactic is to use this tool to give accurate target projections.  To do this, open the Fib Retracement settings and remove all levels EXCEPT for 4.0 and 4.5, then save it as a default. This will give you this move’s projected 4-4.5 standard deviations.   

Next, draw from the SWING HIGH of the move to the SWING LOW that preceded the bullish engulfing candle. This will project a price target at the 4-4.5 standard deviation, allowing you to enter trades with a high reward-to-risk ratio.

Now we have our target; we can add Bollinger Bands® to give us some extra confirmation to look for entry into this trade. 

As we can see in the image below, our bullish engulfing is bouncing nicely off the midline of the Bollinger Band, after being rejected from resistance along the top line the previous trading day.  This gives us a clear entry signal, allowing us to take a 3.13 reward-to-risk trade!

Trading Strategy Summary:

Entry Point: Place limit orders long at the close of the bullish engulfing candle that respects the midline of the Bollinger Bands.

Stop-Loss: Place a stop-loss just below the low of the bullish engulfing candle.

Profit Target: Target the 4.0 or 4.5 Fibonacci projection for precise take-profit levels

Advantages and Disadvantages of Trading the Bullish Engulfing Pattern

The bullish engulfing candlestick pattern is a classic trading signal that traders have counted on for decades due to its reliability and occurring frequency. However, like any other signal in technical analysis, trading the bullish engulfing pattern has pros and cons.

Advantages 

• High Probability Setup: Bullish engulfing patterns often indicate strong reversals and continuations, making them loved signals in trending markets by many traders worldwide.
• Widely Recognized: This pattern is easy to identify and is well-known across all markets, making it accessible for both novice and experienced traders.
• Versatile Across Timeframes: Bullish engulfing patterns work effectively on various timeframes, from intraday charts to weekly and monthly charts.

Disadvantages 

• False Signals in Sideways Markets: Bullish engulfing patterns can generate false signals during choppy or ranging markets, leading to potential losses.
• Delayed Confirmation: Waiting for confirmation after the pattern forms can result in missed opportunities or reduced profit potential.
• Requires Additional Analysis: While the pattern can be a strong signal, it often needs to be combined with other indicators or confluences to improve accuracy.

Closing Thoughts and Key Notes

The Bullish Engulfing pattern is a powerful bullish reversal signal, especially during a retracement or pullback during a broader uptrend. It’s characterised by a small bearish candle completely engulfed by a larger bullish candle.

1. Look for this pattern during a short-term downtrend as it signals a potential reversal, or during a pullback within a broader uptrend.
2. Use alongside technical indicators like Bollinger Bands or moving averages to improve consistency and confirm the signal before entering a trade.
3. Bullish engulfing patterns tend to be stronger when they appear at key support levels or during pullbacks in overall uptrends, making them more reliable signals.
   

FAQs

What is a Bearish Engulfing Pattern?

A bearish engulfing pattern is a two-candle reversal pattern that typically occurs at the top of an uptrend. It forms when a smaller bullish candle is followed by a larger bearish candle that completely engulfs the previous candle’s body. When a bearish engulfing pattern occurs, it often signals a potential reversal from a bullish trend to a bearish trend.

How do I differentiate between a Bullish and Bearish Engulfing Pattern?

The key difference lies in the direction and the positioning of the candles. A bullish engulfing pattern occurs when a smaller bearish candle is overtaken by a larger bullish candle, often signalling the end of a downtrend. In contrast, a bearish engulfing pattern occurs when a smaller bullish candle is overtaken by a larger bearish candle, often indicating the end of an uptrend.

When is a Bullish Engulfing Pattern most reliable?

A bullish engulfing pattern appears most reliable as an explosive move after a prolonged downtrend or as a continuation signal during a strong uptrend. It is often confirmed by other technical indicators or patterns, such as support levels or Fibonacci retracement levels.

Can the Bullish and Bearish Engulfing Patterns be used in all timeframes?

Yes, both bullish and bearish engulfing patterns can be applied across various timeframes, but they are most effective on longer timeframes like daily or weekly charts. Shorter timeframes may produce more false signals.