Bearish Engulfing Pattern in the Dow

Today’s near 300 point Dow Jones decline also printed a potential “Bearish Engulfing” candlestick pattern at resistance, which could signal more bearishness is ahead.

Let’s look at the Daily chart and drill down to the smaller time frames:

The Bearish Engulfing pattern occurs when the second day completely overtakes the previous day’s high and low. Technically, only the ‘real body’ must engulf the previous day’s ‘real body,’ but today’s high is greater than yesterday’s high and also today’s low is lower than yesterday’s low, meaning this pattern has increased significance.  Keep in mind that yesterday’s gap meant that the market increased more than it fell today, but the actual ‘body’ (intraday price movement) formed the engulfing pattern, so this is a caveat to watch.

The fact that this pattern occurred at key resistance (the falling 50 period moving average) helps increase the odds of potential follow-through to the downside. Recall that there are no guarantees in trading.

Let’s view the 15-minute chart and look at some key divergences which set up recently:

Notice the Positive Divergence on the left side of the chart which resolved nicely to the upside. Now, notice the negative divergence that resolved itself today sharply to the downside. Recall that momentum often precedes price action.

Finally, let’s view the intraday 5-minute chart for some hyper-signals:

Notice that I am mainly using price and the key averages to set-up the simplest trades possible.

The first green arrow represents a “buy” trade which is a simple retracement in a trend entry. Target = Prior Swing (which failed to reach the goal).

The text “Market Losing Steam” isn’t actually a trade, but is a warning sign that the bulls can’t push the market higher. It’s a “market structure” observation that lets you know that momentum is decreasing to the buy side, much like a ball being thrown into the air first slows down before stopping in mid-air and then reversing to come back down to earth.

Finally, there were two “Confluence Short-Sell” trades which set-up due to a retracement to the dual resistance levels of the 20 and 50 period moving averages. One could have classified the 1:30pm trade as a type of “Bear Flag” short-sell trade, but the market didn’t give us a good enough 45 degree angle to increase our confidence there.

Finally, aggressive traders could have played the “Counter-Trend Support Trade” which was good for a very small target only, due to the fact that the trade was countertrend. The test of the 5-minute 200 period moving average set-up this trade.

Finally, another high probability retracement trade occurred at the end of the day when price rallied to $123 (Dow 12,300) and found significant resistance there.

I recommend taking the daily action (or intraday action) and annotating where your ‘ideal trades’ would have been so that you can increase your skills in pattern recognition and trade set-ups in a calmer environment.