For long-term investors, candle patterns can provide an early warning sign that a trend change is afoot. So when I noticed a proliferation of bearish engulfing patterns on the stockcharts.com technical scans, I dug deeper into the individual charts to look for signs of distribution.
On January 29, 2018, there were 146 bearish engulfing patterns found, including 42 on NYSE-traded stocks. If you’re not familiar, this is a two-bar pattern seen during an uptrend where you have one long up candle followed but a longer down candle. The real body of the second candle “engulfs” the real body of the first candle.
If you use bar charts, these candles will appear similar to “outside days”, where the high-low range of Day Two eclipses the high-low range of Day One. While these are short-term bearish signals, I’ve found they can often indicate signs of distribution that later become reflected in larger scale trend changes.
For example, in the chart of Johnson & Johnson (JNJ), you’ll notice a bearish engulfing pattern highlighted in orange.
I usually make note of the low of the pattern, and use a breakdown of that level as a confirmation of the short-term sell signal. In this case, JNJ corrected down to the 50-day moving average around 139 before continuing its uptrend.
It’s important to note that a bearish engulfing pattern does not tell you that a bull market is over. It simply demonstrates short-term weakness that is likely to manifest into a correction. The long-term trend should still be in place, assuming a continuation of the pattern of higher lows and higher highs.
I noticed Visa (V) on the list when I reviewed it last night. This is important to note as it is what I consider one of the three bellwether stocks (GOOGL, JPM, V) of this bull market.
When stocks like Visa start to show short-term distributive patterns, it tells me that a market correction may be imminent.
David Keller, CMT
Sierra Alpha Research LLC
David Keller, CMT is President of Sierra Alpha Research LLC, a boutique investment research firm focused on managing risk through market awareness. He is a Past President of the Market Technicians Association and currently serves as a Subject Matter Expert for Behavioral Finance. David was formerly a Managing Director of Research at Fidelity Investments in Boston as well as a technical analysis specialist for Bloomberg in New York. You can follow his thinking at marketmisbehavior.com.
Disclaimer: This blog is for educational purposes only, and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.