Psychology behind bearish engulfing candlestick pattern
One of the most important reasons for the popularity of candlestick charting is the pictorial representations of stock prices and the way the market information is displayed, so that traders can use maximum information to his or her advantage.
There are at least 130 odd candlestick patterns that traders use for different market conditions as well as for trade set-ups. These patterns can be classified into continuation patterns and reversal candlesticks patterns. Reversal candlesticks patterns tell us why an important reversal in the trend is taking place.
From the low of March 2020, the benchmark indices have surged over 100 per cent. Hence, everyone is looking for a trend reversal. So, let’s know which is the most prominent reversal pattern?
It is popularly known as the bearish engulfing candlestick pattern. It is considered to be a bearish reversal pattern as it usually occurs at the top of an uptrend or near a potential resistance zone. This pattern consists of two real bodies of opposite colours. The second candle’s body completely engulfs the previous day’s body.
Rules of identification:
- The stock or index must be in uptrend. The colour of the first candle must reflect the trend, which is a green candle in the uptrend.
- On the second day, the stock or index must open higher than the previous candle’s close while closing must be lower than the opening of the previous candle.
- The body of the first day’s candle must be completely engulfed by the second day’s body.
Psychology behind the pattern:
During the uptrend, the price opens higher than the prior candle’s close, which indicates the strong bullish sentiments, but the rejection of the gap-up opening is a first bearish sign. Thereafter, wiping out the entire gains of the previous candle adds even more bearish sentiments. In addition to this, the formation of a large bearish candle indicates that this was a sudden and decisive shift to the bearish sentiment.
Emotionally, the uptrend has been damaged significantly. If on the third day, the price remains lower, then it means that a major reversal of the uptrend has occurred.
In the above chart, the stock of Piramal Enterprises Limited has formed a bearish engulfing candlestick pattern as of April 01, 2019. Thereafter, the stock has lost nearly 37 per cent in the next 53 trading sessions.
In the above chart, Nifty index has recently formed a bearish engulfing candlestick pattern on the weekly chart. Last year, in January 2020, after forming a bearish engulfing pattern at a lifetime high, the index witnessed one of the fastest bear markets in history as it fell about 40 per cent. There was another bearish engulfing pattern that had formed in the last week of August 2020 and at that time, the index has witnessed correction of nearly 5 per cent in the next four weeks.
On the daily chart, the stock of Bank of India has also formed a bearish engulfing candlestick pattern after a sharp upmove, which indicates a possible trend reversal in the stock.