In this Knowledge bank article we will cover another Japanese candlestick pattern, the widely-used two-candlestick bullish engulfing pattern. The first candlestick represents a falling share price - in the image below in red. The second candlestick represents the share price starting low and ending up at or near its highs - typified by the green candle.
The size of the red candlestick is not consider to hold significance. The second should be a full green candlestick. As the name dictates, the green candle must totally engulf the the body of the previous red candle, and ideally (not compulsory), it would engulf the shadows (tails) as well. Shadows are permitted but should be small in both candles.the bigger
The bullish engulfing pattern is used when a stock has been declining. The theory is that after a period of selling pressure the green candle forms because the stock has opened below the previous close and buyers have moved in and pushed the price higher. The larger the green "
engulfing" candle, the more bullish the reversal. The bullish engulfing pattern basically represents a change in investor sentiment.
As always, confirmation is required. Further strength in the share price in the following time period is required to provide confirmation of the reversal pattern.
The exception to this rule is if the first real body of the engulfing pattern is a doji. Thus, after an extended fall, a doji engulfed by a very large white real body could be a bottom reversal.
Practical Application The chart below is of Bluescope Steel (BSL) from late August to early December 2006. As you can see in the chart below, there must firstly be an existing prior downtrend for the bullish engulfing pattern to be valid.
The above chart clearly highlights the bullish engulfing pattern (yellow circle). Notice that on the next day the next candle gapped up thereby confirming the reversal. Notice that the MACD crossover (aqua circle) also confirmed the reversal and the RSI (green circle) started moving up from a near oversold position.