This Very Rare Bearish Engulfing Pattern Could Signal Near-Term Drop of 5 to 20%

By: Chris Guthrie
Published March 7, 2019
04:00 AM GMT

As a technical analyst, I rely on trends and statistics to forecast future movement. While most forecasts lack full accuracy (just ask your local weatherman), they should always be considered. Knowing how to dress for the weather tomorrow helps prepare you from getting drenched or being cold. You would be at a significant disadvantage if you lacked preparation when the forecast was produced. Forecasts in stock markets should not be ignored and being prepared can produce great rewards. March 4th produced an incredibly rare signal for the S&P 500 that should not be ignored.

A candlestick technique known as an engulfing pattern can signal a reversal in markets when certain conditions exist. The body of the candle (distance between a stock price high and low) is larger than the preceding candle's body. The preceding candle's body fits inside the larger, or engulfing candle. Basically the engulfing pattern experienced a much larger trading range from open to close than it did the prior day. The high of body top was higher in the engulfing candle and the low of the body was lower in the engulfing candle. While most engulfing patterns do not consider the day's high and low price in the size of the candle, its inclusion can help identify rare circumstances.

Rare Bearish Engulfing Pattern

Very Rare Bearish Engulfing Pattern

March 4th saw a very rare engulfing pattern in which the highs of the day were higher than those achieved in the index over the prior 6 trading days. At the same time, the lows on March 4th were lower than those experienced in the prior 6 days as well. This was a signal to me requiring research for the rarity and significance of such an event. Over the previous 40 years, this has occurred only 15 times for the large market index. There are roughly 252 trading days in a year. There have been roughly 10,080 trading days over the past 40 years. This pattern has occurred 0.149% of that time. This event is considered 'Very Rare' based on the occurrence percentage on the website. I studied the last 10 occurrences dating back to 1993. The first thing I realized is this pattern lead to a bullish market 80% of the time. This is great news for your 401K! But once I peeled back the onion, I realized the obvious movement was not the case. What about the other 20%? After all, the pattern is not bullish 100% of the time.

July 2017

A Bullish Case

A similar pattern occurred on July, 27, 2017. This event had an engulfing pattern with a larger range than the prior 6 days, identical to our present occurrence. The index briefly broke out of the engulfing pattern's range to the upside before dropping 2.68% from the patterns high on July 27. It took 31 days before the July 27 high was finally surpassed for good. Coming into the pattern, the index was moving up. Once it clearly broke from the July 27 pattern the index continued to move up.

Not A Rare Bearish Engulfing Pattern

December 2013 & January 2014

A Bullish Case

A similar pattern occurred twice around the end of December 2013 and beginning of 2014. On December 18, 2013, the same engulfing pattern occurred with a larger range than the prior 6 days. The index immediately broke out of this range within 2 trading days before it reoccurred again on January 13, 2014. Once again, the index broke above the January 13 range within 2 trading days. The index did eventually fall after the second break out. The bottom was 5.72% from January 13 top, before the it eventually continued upward. The index was trading up before both occurrences and continued up in the end. However, it did take 34 trading days from the January 13 high to eventually leave the high on a more temporary basis. In both instances, the range was broken to the upside first.

Not A Rare Bearish Engulfing Pattern

April 2011

A Bearish Case

Once again, a similar pattern occurred on April 8, 2011. Once again the engulfing pattern occurred with a larger range than the prior 6 trading days. A key difference from the previously mentioned occasions saw the index break out of the engulfing pattern's range to the downside first. The index closed below the engulfing pattern on the second day and then began to whipsaw. Fifteen days after the pattern, a gain from the pattern's high occurred which gained 3.60% from that high. The next moves were continually to the downside. The index finished 6.08% lower from the pattern's high on April 8 which occurred 47 trading days later. After additional whipsawing, the index was 19.78% lower than the high on April 8, and 21.58% lower from the first top after the engulfing pattern. The index was trading sideways prior to this entire event.

A Rare Bearish Engulfing Pattern

January 2005, April 2006, & January 2007

A Bullish Case

Over the course of a two year period, the engulfing pattern occurred three times. All three instances broke out of the pattern's range to the downside first, followed by a rise above the range before dropping greater than 4%. The first pattern occurred on January 3, 2005. In this instance, the engulfing pattern had a greater range than the movement in the prior 7 days. Most movement after the pattern was to the lowside with the lowest point leading to a 6.70% decline from the engulfing pattern's high on January 3. It took 131 trading days after the pattern to close and stay above the engulfing pattern's high.

The second pattern occurred April 7, 2006. Like our current 2019 engulfing pattern, the range encompassed the prior 6 trading days. The lowest move came 46 days after the pattern presented itself on April 7 which resulted in a 7.21% drop from the April 7 high. Although the index traded moreso to the downside following the engulfing pattern, the index began to firmly trade above the pattern's high after 117 trading days.

Not A Rare Bearish Engulfing Pattern

The final pattern in this trio occurred January 3, 2007 and engulfed the range of the index over the prior 8 trading days. The index price was mostly above the engulfing pattern high over the next 62 days, however, it did reach a low point 4.58% below the January 3rd high. 63 days after the engulfing pattern, the index continued its upward trajectory. It did however begin the "Great Financial Crisis" 200 days later.

The overall direction of the index prior to each engulfing pattern was upward trending. This direction continued after each engulfing pattern high was firmly surpassed no later than 131 trading days.

January 2001

A Bearish Case

Once again, a similar pattern occurred on January 3, 2001. Once again the engulfing pattern occurred with a larger range than the prior 6 trading days. The index opened above the engulfing pattern high the very next day but closed below the said high. The index was choppy over the next 54 days which ultimately lead to a 19.78% decline. The index returned back to the engulfing pattern range in May 2001. The index permanently left the range 108 days after the engulfing pattern appeared. The index was trending downward prior to the pattern and continued such movement afterward leading to a nearly 40% drop below the pattern's low to a bottom in October 2002.

A Rare Bearish Engulfing Pattern

May 1997

A Bullish Case

While a similar pattern occurred on May 30, 1997, the bottom of the engulfing pattern range was never broken. The top of the pattern's high was surpassed 5 days later and the index continued to soar. The index was trending up prior to the pattern and the direction continued afterward.

Not A Rare Bearish Engulfing Pattern

May 1993

A Bullish Case

The most unique accomplishment of a similar pattern occurred May 19, 1993. The index engulfed the prior 13 trading sessions in one day. The low of this range was never broken after the pattern date. The index was trending up prior to the pattern and the trend continued after day 59.

Not A Rare Bearish Engulfing Pattern

Analysis of the Rare Engulfing Pattern

Two strong commonalities were observed during the aforementioned engulfing patterns. The index always continued the direction it was moving before the pattern occurred. The debatable point in our current situation is what direction was the market moving before the engulfing pattern occurred? The index has been moving up since the lows on December 26, 2018, but it is certainly arguable the index has been moving down since the highs on September 21, 2018. The longer range trend dictated direction in the studied situations above. With this being the case, the motion of the index was likely downward prior to the engulfing pattern. Based on this point, the likely future short-term direction will also be descending.

Second, first breakout of the range dictated if the index would drop in the short-term. Of the four occasions the engulfing pattern's range was broken to the downside first, the index dropped a minimum of 4.58% from the engulfing pattern's high. A 4.58% drop from the high on March 4, 2019 would bring the index down to at least 2687.75. As this was the minimum drop, we would likely see something more significant.

The top and bottom of the engulfing pattern range has not been broken as of the March 6, 2019 close. However, the March 6 close is mere points above this low. The forecast to protect against is additional losses in the index, funds, and market as a whole if the low is broken first. The critical things to watch over the next few days and months will be which direction the index breaks from the range first. You should buckle up if that is to the downside.

Summary Chart of Similarly Studied Patterns

Current As of May 3, 2019 Close

Date Direction Prior To Engulfing Pattern Direction of Engulfing Pattern Initial Break From Pattern Range Initial Break % From Pattern Close Price Max Move % Up From Engulfing High Before Clearing Max Move % Down From Engulfing Low Before Clearing Days to Clear Range From Pattern Date Direction After Clearing Range
March 4, 2019 (current pattern) Up Down Down -1.64% 4.87% -1.64% TBD TBD
July 27, 2017 Up Down Up 0.62% 0.27% -1.73% 31 Up
January 13, 2014 Up Down Up 1.74% 2.92% -4.27% 65 Up
December 18, 2013 Up Up Up 2.22% 4.69% -1.70% 38 Up
April 8, 2011 Up Down Down -2.52% 2.32% -4.90% 75 Down
January 3, 2007 Up Down Down -0.89% 2.25% -3.40% 62 Up
April 7, 2006 Up Down Down -2.54% 0.96% -5.79% 117 Up
January 3, 2005 Up Down Down -3.19% 2.30% -5.35% 217 Up
January 3, 2001 Down Up Up 0.20% 2.64% -15.18% 108 Down
May 30, 1997 Up Up Up Up Up None 5 Up
May 30, 1997 Up Up Up 1.80% 1.73% None 59 Up

Counter Analysis

The above analysis is likely to forecast upcoming movement for the index. No model is perfect (once again, ask a weatherman). Prior trends could inaccurately drive a bear or bull trap where the index jukes one direction leading everyone to believe the trend analysis is accurate before permanently reversing course. A rise beyond 2850 before a drop below 2725 would likely prove this analysis void. I follow the trends, patterns, and statistics for a living and have success greater than 85% of the time. I know where I am hedging once the engulfing pattern's range is broken.

Disclaimer: I do not currently have any positions on the index or funds discussed in this article. I have purchased volatility call options. I do not intend to enter additional positions at the time of writing. This article is for reference only and should not be solely relied on to predict future movement. Historical movements and technical indicators should never be the sole basis for entering positions involving risk. You should not take a risk without fully understanding the system, market, and having established a trading discipline. Make sure appropriate research is conducted prior to taking any risk in a marketplace. The author and Limitless Life Skills LLC do not have an interest, outside of the disclosed positions, or relationship with the companies mentioned in this article.

Please share this article if you found it valuable and to get our name out.