Bearish engulfing candlestick patterns that signal a decline in a stock's price is quite possible. The pattern is fairly simple and quite common, which also means it is susceptible to providing false signals. Yet, the appearance of the pattern in these stocks shows that there was strong selling on Tuesday, November 6, and therefore should not be ignored. Also, since the major indexes moved higher on November 6 (S&P 500 up 0.79%), the fact that these stocks created a bearish pattern on such a day implies weakness. The pattern is created by an "up" day followed by a "down" day; the down day's open is higher (or the same) than the prior close, and the down-close is lower than the prior closing price. In essence, the larger down bar "engulfs" the up day, showing selling power overtook buying pressure.
SEE: The Basic Language Of Candlestick Charting
NextEra Energy (NYSE:NEE) created a bearish engulfing pattern after a large down candle on November 6, engulfing the prior real body - the fat part of the candle is representing the difference between the open and close - which was quite small. While the large red candle shows the current selling pressure, the most significant technical price area is just below $69, which represents support. If the price falls below that level, another wave lower is likely. Engulfing patterns don't provide a profit target, yet a breach of $69 has an initial target of $67 followed by $64. The stock has been fairly strong throughout the year, so a rise back above $70.30 nullifies the bearish signal.
Crocs (Nasdaq:CROX) has already had a tough year closing at $12.63 on November 6, which is about 44% below the $22.59 high seen in April. After a brief rally the first few days of November, the engulfing pattern shows there is still selling to be done. The recent low is $12.44, and is the lowest level since September 2009. There is little support until $10, which is the initial target if the price falls through the recent low. If the downtrend continues the long-term target is $6. A rally above $14 may spark some buying and nullify the bearish pattern, but the overall trend remains down as long as the stock below $17 ( long-term trendline).
SEE: Technical Analysis: Support And Resistance
Community Health Systems (NYSE:CYH) has marched higher throughout the year, but is encountering resistance at $30. The stock was unable to hold the level in October, and the engulfing pattern on November 6 near that level again shows buyers may be out of steam. The bearish engulfing pattern signals a decline toward support just above $26. If $26 is broken the target is $22.50. A rise above $30.05 nullifies the bearish pattern and signals the uptrend, which has been in place throughout 2012 is still in play.
SEE:Interpreting Support And Resistance Zones
Sysco Corporation (NYSE:SYY) created a 52-week high at $31.90 in October, but on the most recent rally in November the stock only managed a high of $31.78 before declining. The lower high and engulfing pattern on November 6 signal potential trouble for the stock. Support is just above $30, and if penetrated the target is $28.30. On the bullish side, there is an upward sloping trendline intersecting near $30.50. If that trendline fends off further declines, it represents a buying opportunity as the stock will likely once again challenge the $31.90 area.
The Bottom Line
Bearish engulfing patterns show that sellers are present, and momentum has shifted to the downside compared to the prior day. The pattern is fairly common though, so it is best to combine with other chart patterns and view it in the context of current trends. The other forms of analysis will also aid in establishing profits targets, since engulfing patterns don't provide one. During an uptrend a bearish engulfing pattern alerts you to the possibility of a coming decline, while in a downtrend warns that the selling is continuing. False signals do occur though, so always manage risk.
Charts courtesy of stockcharts.com
At the time of writing, Cory Mitchell did not own any shares in any company mentioned in this article.