Definition — what a bearish engulfing pattern is
– A bearish engulfing pattern is a two-candle reversal setup on a price chart. The first candle is upward (a “bull” candle: close > open). The second candle is downward (a “bear” candle: close open).
– Candle 2: bearish (close 1.2 for robustness; higher is better).
– Kelly fraction (position guide, not absolute size): f* = (bp − q)/b where
– b = average win / average loss,
– p = win probability,
– q = 1 − p.
– Use fractional Kelly (e.g., 1/4–1/2 Kelly) to reduce volatility. Note: Kelly can suggest aggressive sizes; interpret cautiously.
Checklist — pre-trade (quick)
– Thesis: What is my edge for this trade? (pattern, catalyst, indicator)
– Risk: Entry, stop, size, max loss in $ and % of account.
– Reward: Target(s) and R:R (reward-to-risk ratio).
– Execution: Order type (limit/market), routing, expected slippage.
– Market context: News events, earnings, macro releases, market breadth.
Checklist — execution & management
– Place stop and scale rules before entering.
– Use limit entries when appropriate to control fill price.
– If using intraday stops, track volatility and adapt size (per your plan).
– If stop is hit, accept the loss and move on (unless you have a pre-defined re-entry
re-entry rule). – If you plan a re-entry, define exact conditions (e.g., price retest of the pattern low/high with lower volume, or wait for a new signal). – Avoid “averaging up” or adding to a losing position unless the add is part of a predefined scaling plan and funded by reducing size elsewhere.
Checklist — risk management while live
– Monitor position-size vs. realized volatility; reduce size if realized intraday volatility > planned volatility.
– Use a trailing stop rule or profit-schedule before entering (e.g., take 50% at 1R, trail remainder at breakeven + ATR/2). Define ATR = average true range (volatility measure) and state the ATR period.
– Record intraday slippage and fills; update expected slippage in your plan if it exceeds historical norms.
– If market-wide flow (e.g., index gap, news) invalidates your thesis, exit even if stop not hit. Predefine what macro events will force an early exit.
Post-trade review checklist (end-of-day / end-of-trade)
– Record: entry price, exit price, stop, size, P/L in $ and % of account.
– Confirm whether trade followed the plan: yes/no + deviations with reasons.
– Outcome review: what went right, what went wrong, what to adjust (stop placement, timing, size).
– Track statistics: win rate, average win/loss, expectancy = (win % × avg win) − (loss % × avg loss). Update position-sizing inputs from realized expectancy over a reasonable sample (50–200 trades).
– Archive chart with notes and attach market context (news, volume, other indicators).
Worked numeric example (short using a bearish engulfing signal)
Assumptions:
– Account equity: $50,000.
– Risk per trade: 1% of account = $500.
– Instrument: Stock XYZ. You plan a short after a bearish engulfing candle.
– Entry: short at $45.00 (limit filled).
– Stop: above the engulfing candle high + buffer; stop at $47.00.
– Per-share risk = $47.00 − $45.00 = $2.00.
Position-size calculation:
– Shares to short = risk per trade ($500) ÷ per-share risk ($2.00) = 250 shares.
– Notional short = 250 × $45 = $11,250 (useful for margin/borrow checks).
Target and R:R:
– If target is 3:1 reward-to-risk (3R), profit per share = 3 × $2 = $6 → target price = $45 − $6 = $39.00.
– Potential profit = 250 × $6 = $1,500. Potential loss if stopped = $500.
Notes and checks before entry:
– Confirm borrow availability and short borrow cost with your broker (may affect net return).
– Confirm no earnings or hard-to-borrow alerts scheduled.
– Check market context (index behavior, sector strength).
– If ATR(14) = $1.20 and you prefer volatility-based stops, you might use stop = entry + 1.5 × ATR = $45 + $1.80 = $46.80 (round as appropriate) and recalc size.
Practical pattern rules and verification steps for a bearish engulfing trade
– Definition recollection: A bearish engulfing pattern consists of a smaller bullish candle followed by a larger bearish candle whose real body fully covers (engulfs) the prior candle’s real body. It signals short-term seller dominance but is not a standalone guarantee.
– Context: Prefer bearish engulfing at or near a resistance area or after a prior uptrend/rally. A bearish engulf