Talking Technicals – Candlesticks

So, you own a stock that has been rallying nicely. You are making money and all is going well. At some point the question crosses your mind “When do I sell?” You don’t want to just take a guess, but you also don’t want to give up any more profit than you have to by letting the stock drop. What sign might a stock give you that it’s run could be over? Time to talk about another candlestick pattern!

Bearish Engulfing Pattern

A bearish engulfing candle pattern forms when a small white candlestick is followed by a large black candlestick that eclipses or “engulfs” the smaller white one. (Keep in mind; the color of candles may vary depending on the site you are using to conduct your analysis.) In other words, the high and low of the black candle body are higher and lower than the white candle’s body, respectively. Another important part of the pattern is that the stock it forms within must be on an upward or bullish trend prior to the formation of the pattern.

Bearish engulfing patterns are reversal patterns. If you think about what has happened within those two day’s price action it probably makes sense: The stock has been rallying. It opens today and rallies a bit higher (white candle), but the move is small and doesn’t go far (losing steam?). The next day, the stock opens higher than the close of the prior day, but then the stock sells off throughout the day (black candle), ending up closing lower than the prior day’s open.  It just doesn’t sound like a good day, and more importantly, it sounds like a stock that has lost momentum and reversed it’s trend higher.

A great example of this formation is found on a stock that I currently have in my watchlist – ULTA (Ulta Salon & Fragrance, Inc.). By looking at the chart below you can see that ULTA has just formed a shooting star candle pattern. The company itself is within the services sector and more specifically in personal services.

As you can see from my notations (red), ULTA has been rallying as required from recent low of $95. Yesterday the stock formed the textbook definition of a bearish engulfing pattern, which should mean lower prices ahead for the stock. Most traders will wait for a “confirmation” of the pattern though, which is typically considered a lower closing price the next day. Should provide a great short trading opportunity or the chance to lock in some gains!

Before making any trading decision, remember to consider which side of the trade you believe gives you the highest probability of success. For example, analyze the overall market to see which direction it is trending. Making this type of decision ahead of time will help you decide which side of the trade you believe gives you the best opportunities. Regardless of your strategy, or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.

Good luck and great profits!