The engulfing bullish pattern is relatively well-known and also easy to spot on price charts. It consists of two candles where the first one is bearish, while the second one is bullish. Also, the body of the second candle “engulfs” the body of the first candle:
As such, this type of patter should be easy to code in computer software used for backtesting or creating trading signals. Nevertheless, the presence of the pattern does not guarantee any bullish action since there are some other criteria that should be satisfied.
At first, the pattern should occur after a downtrend. In my trading, I like when it occurs at some support line (or a support zone) to increase the odds. Other traders combine the engulfing bullish pattern with some indicators (e.g. RSI should be in the oversold zone). The future bullish action should also be considered, e.g. it may be risky if there is a resistance line or resistance zone just above the pattern. Thus, it may be challenging to create a computer program that considers all these facts.
Therefore, for backtesting of the pattern, I used the following strategy:
- The price has decreased during the past days
- There is a high trading volume
- The pattern has to be “confirmed”, i.e. the closing price on the day after the pattern is greater than the highest price in the pattern
- The general stock market and the stock price itself are bullish. It is defined by assuming that 100-day SMA is above 400-day SMA
- Some days before the pattern a local maximum occurred (see the figure below). The price of this day will also be our take-profit target:
The results of backtesting in years 2000-2017 for the Russell 3000 stocks are collected in the table below:
|Total net profit||$65307|
|Number of trades||428|
|Profitable trades [%]||60.28%|
|Average trade [%]||1.54%|
|Number of days held||19|
The results are actually quite good. Pay a special attention to the very low maximum drawdown (about 3%) – there are not so many trading strategies where the maximum drawdown is so low. Also, the percent of profitable trades is very decent and the win/loss ratio more than 1.0 – this is again very promising.
More results of this strategy were also published in:
P. Kosinski: Testing the engulfing bullish pattern, Technical Analysis of Stocks & Commodities, December 2018