The bearish engulfing pattern fails

I provide an example of a failing pattern for every successful pattern in this book, and in Figure 8-3, I highlight what can happen when a bearish engulfing pattern goes wrong. This unfortunate outcome occurs on a chart of the Japanese Yen futures. The bearish engulfing pattern shows up but fails pretty quickly, and the uptrend just keeps going higher.

This scenario looks ripe for a bearish engulfing pattern: A clear uptrend is in place and actually appears to be slowing a bit (a good sign). The bulls continue the trend on the setup day, and then on the signal day, a small gap opening appears. At first the bulls push prices much higher, but then the bears take over, and when they start selling, it's powerful enough to cover the setup day's bullishness, and then some. If you see this pattern on a chart, you may have good reason to get excited, but things go sour quickly.

The day after the pattern appears, the bulls get back in on the action, and the price closes higher than the opening of the signal day. The pattern clearly fails, but if you trade on it, you can avoid heavy losses if you place a stop at the right level.

When working with bearish engulfing patterns, I place my stops at the open of the second day. That's when I can tell that the bulls have again seized control of the price action, and I know that can continue for some time. It's always prudent to have a stop in place, and that may be a good level to choose to put your stop. I advise you to place your stops at the same level.

Figure 8-3:

A bearish engulfing pattern that fails on a chart of the Japanese Yen futures.

Figure 8-3:

A bearish engulfing pattern that fails on a chart of the Japanese Yen futures.

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