Bullish Engulfments are found on stock charts to signal a change in definite change in direction from the downside to the upside. Not only are they fairly easy to spot, but they are easy to manage and maximize. Let's explore.
What To Look For
What you are looking for visually is a single day when a stock falls below the previous days lows, then surges to the upside to close higher than the previous day's highs on higher volume higher than the day prior. Let's take a visual look from investopedia.com:
Both candlesticks represent a single day of price movement for the stock. Look at how the right candlestick simply "engulfs" the left one, this is showing that the bulls (buyers) are strongly showing they now have control of the stocks direction.
A Real Life Example
I found a stock chart of Celgene Corp (CELG) which offers almost a perfect example for illustrating how a bullish engulfment looks and what happens to the stock after. First let's see the bullish engulfment:
Now, as you can see on March 14th, 2007 this technically isn't a true bullish engulfment because the opening price (bottom of the box) wasn't lower than the day previous. But, as you can see in the next chart, it was still accurate enough to signal the start a new move to the upside.
Celegene over the next two and a half months moved all the way up above $66 before topping out due to an exhaustion gap (a technical pattern for another day :twisted:). If you would have bought the day after Celgene had its original bullish engulfment you would have made around a 27% return, not bad for a simple pattern.
The Easy Way to Buy and Minimize Risk
The best part about trading bullish engulfments is that are extremely easy to minimize downside risk with. Let's say we saw Celgene end that day in March with the definite bullish engulfment pattern, we would then buy the following morning and place a stop below the engulfment day's low. This guarantees us that if the pattern fails, we get stopped out (sold out) with a minimal loss.
The Advanced Way to Buy and Minimize Risk
There is also a daytrader's way to buy into this pattern which I found over at Solution Seeker. Dave says:
- Previous day needs to close down relative to the open.
- For the next day, if the open is less than the previous day's close, then place a buy stop order above the previous day's open.
- If filled, place a protective sell stop order below the previous day's low or entry day's low.
- If the stock does not close above your purchase price, consider exiting the position on the close.
Trading bullish engulfments this way takes discipline - the discipline to exit the position if it does not move favorably in your direction quickly. But, if you do catch the pattern correctly, you are really catching the true bottom of the stock.